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spk08: Good morning. My name is Nick. I will be your conference operator today. At this time, I'd like to welcome everyone to the Berwick's Fourth Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. Please note that this event is being recorded. Now I'd like to turn the program over to your host for today's conference call, Lynn Maxeiner, Vice President of Investor Relations.
spk00: Great. Thank you, Nick. Good morning and welcome to VRDA's fourth quarter 2020 earnings conference call. Joining me today are VRDA's Executive Chairman, David Cody, Chief Executive Officer, Rob Johnson, Chief Financial Officer, David Fallon, and Chief Strategy and Development Officer, Gary Niederkrum. Before we begin, I point out that during the course of this call, we will make forward-looking statements regarding future events, including the future financial and operating performance of VRDA. These forward-looking statements are subject to material risk 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 registration statement or proxy statement and other filings 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.virtu.com. With that, I'll turn the call over to Executive Chairman David Coates.
spk10: Thanks, Len. As I reflect on the past year with Vertiv, I'm even more encouraged that everything we discussed in the Roadshow has been proved to be even more true today. Vertiv has a great position in a good industry, and we can differentiate with technology. Sales growth and margin rate expansion opportunity abounds, and we have a team that's making it happen. That opportunity is shown brightly in 2020. We were able to hold sales flat and significantly increase orders in a terribly difficult year. We were able to increase our margin rate on flat sales, which is always difficult. And at the same time, we ramped up investment in R&D, other growth drivers, and process initiatives like the vert of operating system, vert of product development, functional transformation, and customer view, the vert of user experience. The same is true for 2021. as Vertiv guides to sales growth, margin rate expansion, and the reinvestment that drives both in 2022 and beyond. Cash and overall liquidity improved markedly, and net leverage is down a lot more than anticipated, especially in a COVID year. My confidence has increased, not decreased, over the past year. No matter where I look in Vertiv, we're making great progress, As Tim Buck III said in their 1986 song, the future's so bright, we've got to wear shades. I felt that way a year ago, and I feel that way even more so today. With that, I'll turn the call over to Rob.
spk11: Thank you, Dave, and I truly appreciate your partnership and the good advice you continue to provide to me and my executive leadership team. I also want to thank Divertive employees for their efforts in Q4 and throughout last year. They pulled together and demonstrated how our collective efforts can accomplish amazing feats during a very challenging time. They've adopted to a can-do attitude, use creativity, ingenuity, and outside-the-box thinking in order to serve our customers during this pandemic. I commend my team, my board, and our many partners for delivering the results I will share with you today. Moving to slide three. Overall, the demand side of our business was very promising as Q4 sales were up over 11% compared to Q4 of 2019, driven largely by significant growth in the European and Asia Pacific regions. Orders for the quarter were up 9% when compared to the fourth quarter of last year. And I'm pleased to remind you that the orders for Q3 were already up 15% as compared to Q3 of the previous year. Our backlog remains at an all-time high and is up $450 million from the end of 2019. We will talk more specifically about the demand side of the business over the next few slides. From a profitability standpoint, our adjusted EBITDA was $187 million, which was up over 25% from last year's Q4. This resulted in adjusted EBITDA margin expansion of 160 basis points, driven higher by sales, higher contribution margin, and lower fixed costs on a percentage basis. Additionally, our free cash flow at the end of Q4 improved over the same time period last year by $86 million to $175 million because of higher earnings and lower transformation spending. Turning to the full year results of 2020, we delivered $39 million more in adjusted EBITDA as compared to 2019, with sales down approximately 1%. This equates to 110 basis point improvement in adjusted EBITDA margin versus the prior year. Our free cash flow improved $171 million over last year to $163 million, driven primarily by higher adjusted EBITDA and lower cash interest. Looking at 2021, we anticipate above-market top-line growth, increase in profitability, an even stronger balance sheet, all while continuing to invest significantly in strategic areas like research and development and sales and marketing. Finally, I wanted to let you know that we have transitioned the measure of profitability from adjusted EBITDA to adjusted operating profits. While there are a few moving parts associated with this transition, this is nothing more than continuing on our committed path to keeping our financials and communications as simple as possible. In order to aid the analysts with this, transition, we've included Exhibit 99.2 in our 8 that reconciles all the pertinent information. David will speak to this further during his section as well. Turning to slide four, we've used this slide over the past few quarters to illustrate what we are seeing in our market environment regarding demand. It's been updated here to reflect how things look today. In the cloud and co-location market, we continue to see strong levels of activity in every region, as indicated by the six green buttons in the top two rows. Emerging digital applications such as online education, telemedicine, video, and gaming are benefiting our cloud and co-location customers, and that demand benefits us as well. In contrast, we see the enterprise and small to medium business continuing to be challenged by COVID, as indicated by the red and yellow buttons in row three. Its spending continues to be mixed. We commented last quarter that this segment was slightly more positive in October than it was in July, and it's slightly better today than it was in October. The change is subtle, but it is trending in the right direction. Switching to the telecom side of things, we see little change from last quarter. However, we are seeing an uptick of 5G deployments in U.S. and parts of Asia. Several of our larger U.S. carriers are continuing to roll out 5G, and we expect the rollout to continue for several more quarters. Finally, our commercial and industrial business often tracks GDP, but sometimes the quarterly timing can be different. There was a positive movement in a few light commercial and industrial applications over the past few months. The most notable changes we are seeing are taking place in Europe. So certainly some puts and takes, but overall a strong market picture given our mix of the data center business. The digital applications people use every day continue to become more and more important to daily living as a result of demand increasing for those digital applications so they can be processed, stored, and transmitted. This is creating a significant opportunity for our customers and consequently a significant opportunity perverted. Moving to slide five. To reiterate, the overall demand is strong as evidenced by our order rates and backlog. Each of our world regions saw orders growth between 2019 and 2020, which was led by strength of the cloud and co-location markets. As I mentioned in the prior chart, the enterprise and IT channel markets are still not back to pre-COVID levels, but they are moving in the right direction. The IT channel momentum is evidenced by our integrated rack solutions revenue having increased every quarter in 2020. While we continue to maintain a high level of vigilance around COVID, our backlog is approximately $450 million higher than it was entering 2020, and we are confident about our position in the market for 2021 and beyond. Switching to the supply side, now I'm pleased to report that most of our manufacturing facilities are operating normally. The measures we have taken and the priority we have placed on safety has allowed us to continue to operate in a relatively normal state amid the disruptions caused by COVID. Sometimes those disruptions are daily. Although we've seen a strong appetite in the broader market for some of the components we use to manufacture our products, I'm proud of how we have diversified our logistics and supply chains globally to mitigate any serious consequences. With that, I'll turn it over to David Fallon to walk us through the financials. David? Thanks, Rob. Starting with slide six, this page summarizes our fourth quarter financial results versus last year. Net sales were up $134 million, or 11.4%, 9.5% when adjusted for a $22 million foreign exchange translation tail end. We continued our strong momentum with orders, which were up 9% in the fourth quarter after increasing 15% in the third quarter. Adjusted EBITDA increased $38 million, or 26%, primarily driven by the flow through from higher sales and slightly offset by a foreign currency transaction loss, translating into 160 basis point improvement in adjusted EBITDA margin. Our sales and profitability performance converted into strong free cash flow of $175 million, $86 million higher than last year's fourth quarter. We will review some of the drivers of this improved free cash flow in a couple of slides. Turning to slide seven, this slide summarizes our fourth quarter segment results. Net sales in the Americas were up $3 million, or 0.6%, as growth in telecom was offset by lower services sales, which continue to be negatively impacted by COVID site access issues. Net sales in APAC increased $70 million, or 19%, primarily due to continued strong growth in China across most end markets, including data centers, telecommunications, and industrials. Geographic locations outside China in APAC were up slightly as we continue to deal with site access challenges in some of those jurisdictions. Net sales in EMEA were up $60 million, or 25%, almost entirely in the critical infrastructure and solutions product segment, driven by several larger co-location projects. From a profitability perspective, adjusted EBITDA margin improved in both the Americas and EMEA, but notably in EMEA, where margin increased over 600 basis points from last year's fourth quarter. This improvement was driven by both higher contribution margin and sales leverage on relatively flat year-over-year fixed costs. Higher contribution margin was primarily due to continued operational and procurement improvement, despite a slight negative mixed impact from larger projects. The MIA adjusted EBITDA margin has improved sequentially each quarter in 2020, reflecting the benefits of past transformational spending, the launch of the vert of operating system, and, of course, the leverage benefits of growing the top line while holding fixed cost constant. Next, turning to slide eight, this chart bridges fourth quarter free cash flow from last year. The $86 million increase is primarily a result of higher adjusted EBITDA, lower cash interest payments and lower transformational spending the 175 million dollars of free cash flow in the quarter was higher than our internal expectations primarily driven by the timing of cash collections at the end of december versus early january after beginning 2020 with the use of cash in the first quarter of approximately 200 million dollars we generated $366 million of free cash flow over the last three quarters, indicative of the strong cash generation potential of this business. This free cash flow has allowed us to pay down our ABL completely, and in conjunction with the $157 million of cash we received pursuant to the redemption of the public warrants prior to year end, We increased our liquidity to $964 million at 1231 and assisted by additional cash received in January from the warrant redemption, approximately $100 million. Liquidity currently stands close to $1.1 billion, up from $446 million at the end of the first quarter. Next, turning to page 9, this slide summarizes our full-year financial results. Net sales were down $60 million, or 1.4% from 2019, as higher sales in EMEA and APAC were more than offset by lower sales in the Americas, which was more significantly impacted by COVID site access challenges than the other two regions. When looking at our full year sales result, it is instructed to bifurcate the year over year comparison. Sales were down 13% in the first half of 2020, but up 10% in the second half, in part driven by more challenging comps in the first half of 2019, but also demonstrating the rebound from COVID challenges and the continued resilient growth in our industry. Despite lower full-year sales, adjusted EBITDA increased $39 million, or 7%, and adjusted EBITDA margin improved 110 basis points as procurement and pricing initiatives drove contribution margin improvement. And fixed costs were down $40 million, aided in part by COVID cost-saving actions launched in the second quarter. Finally, on this page, and this is the money chart, free cash flow improved $171 million from 2019 as we benefited from lower cash interest payments, higher adjusted EBITDA, and lower transformation spending. Beginning on page 10, we pivot to looking forward, including with this slide, which discusses our transition to adjusted operating profit as our primary financial metric rather than adjusted EBITDA. For avoidance of doubt, we will not be reporting adjusted EBITDA going forward. We defined adjusted operating profit as operating profit excluding the impact of intangible amortization expense. Operating profit is a gap financial measure that will be included on the face of our income statement, and we show an example on the next slide. with the only adjustments operating profit both prospectively and for historical periods being intangible amortization, which we will also include on the face of our income statement. We believe using adjusted operating profit will greatly simplify our communication and analysis of financial results with analysts and investors, and by eliminating all adjustments other than intangible amortization, We address all components of GAAP financial results, enhance the quality of earnings, and we also, of course, eliminate the previously disclosed historical adjustments. At the bottom of slide 10, we provide a reconciliation of adjusted EBITDA to operating profit and then to adjusted operating profit. As you can see, net-net, the differences between adjusted EBITDA and adjusted operating profit are the historical add-backs and also other one-time adjustments and depreciation expense. And adjusted operating profit is simply operating profit less the impact of intangible amortization. Last item of note on this slide, we will also be restating our historically reported adjusted earnings per share to remove historical adjustments except intangible amortization, and we include those reconciliations on pages 26 and 27 in the appendix. Next, moving to slide 11, this slide illustrates changes in our GAAP income statement presentation going forward, which facilitates our transition to adjusted operating profits. Once again, we will specifically include operating profit, a gap measure, on the face of the income statement. And we will also include components of the previously used other deductions net, including amortization of intangibles. A reader will easily be able to calculate adjusted operating profit for any future or historical period with items included on the face of the income statement. And as Rob mentioned, to aid analysts and investors with this transition, which we hope is a once every 10 or 15-year transition. We have included Exhibit 99.2 to our earnings release 8K, which includes restatements for historical periods, including quarters consistent with this presentation. It also includes revised regional segment information, including reconciliations from historical adjusted EBITDA to adjusted operating profit, and quarterly and full-year reconciliations from historically reported adjusted earnings per share to the prospective calculation removing historical adjustments. And as always, Lynn Maxeiner, our VP of Investor Relations and I, will both be available for any assistance in understanding and facilitating this transition. Next, turning to slide 12, this page summarizes our current financial guidance for 2021. We expect the momentum from the second half of 2020 to continue into 2021 with organic net sales up 7% at the midpoint. We projected adjusted operating profit of $575 million at the midpoint, up 68% from prior year, and up 26% when pro forma for 2020 discrete items, as we illustrate on slide 13. Adjusted operating margin is expected to be approximately 12% at the midpoint, up 420 basis points from 2020, and up 160 basis points on a pro forma basis. Of course, analysts, investors, and we internally will have to recalibrate margin improvement goals on a relative basis using adjusted operating profit as opposed to adjusted EBITDA. With adjusted operating margin for 2021 about 180 basis points lower than the comparable adjusted EBITDA margin, But, of course, the magnitude and substance of our long-term margin improvement goals are unchanged. We expect 2021 adjusted earnings per share of $1.04 at the midpoint, with disclosure of assumptions included on slide 28 in the appendix. Finally, on this slide, we currently expect strong 2020 free cash flow of $285 million at the midpoint, up approximately $120 million from 2020. And we will provide additional detail on this improvement on slide 14 coming up. Next, slide 13. This slide illustrates our bridge from 2020 adjusted operating profit of $342 million to projected midpoint 2021 adjusted operating profit guidance of $575 million growth of approximately 68%. To the far left in the bridge, we pro forma 2020 adjusted operating profit for two discrete items, $92 million for the 2020 restructuring reserve and asset impairments, and $21 million for SPAC transaction costs in the first quarter of 2020. Compared to the resulting $456 million 2020 pro forma figure, we project the operating improvement in 2020, in 2021, of about 26%. Components of this operational increase are illustrated in the bridge and include the following anticipated favorable drivers. higher sales volume, continued contribution margin expansion from procurement pricing and boss initiatives, and net benefit from restructuring of approximately $20 million, including $40 million lower cost from the 2020 restructuring program, offset by $20 million of additional restructuring and related project expense in 2021. These tailwinds are offset by higher anticipated fixed costs, as we discussed in our third quarter earnings conference call, including additional investment of $65 million for R&D and growth initiatives and an anticipated $40 million impact from various one-time COVID cost-saving actions in 2020 that don't repeat. We normally do not spend significant time explaining an other bar, but In this case, there are quite a few variances going each way included in the other bar on this bridge. Tailwinds include $26 million of the FX transaction loss from 2020 and $40 million of cost savings that we expect in 2021, not related specifically to the 2020 restructuring program. Headwinds, offsetting headwinds, include a $30 million negative foreign exchange impact on fixed costs, $25 million for global merit increases, and $11 million of additional depreciation expense. Of particular note, the $51 million of historical ad backs from 2020, which included $13 million for stock compensation expense and $38 million for transformation investments related adjustments as detailed on slide 19 in the appendix is almost entirely offset by a combined 50 million dollars of anticipated expense in 2021 equally split between stock compensation expense and continuing it project implementation costs transitioning to slide 14 We include a bridge for the $122 million projected increase in free cash flow from 2020 to 2021. We expect this increase will primarily be driven by higher adjusted operating profit and lower cash interest payments. These positive drivers will be partially offset by certain headwinds, including 2021 restructuring payments pursuant to the 2020 program. higher CapEx due to delayed 2020 projects and anticipated investment in operational restructuring. In addition, cash taxes are projected to increase due to expected higher profitability in several foreign jurisdictions. Overall, our expected 2021 free cash flow will be somewhat normalized except for the higher cash requirements for restructuring. And CapEx is likely slightly elevated due to the push from 2020 projects and incremental spend from the operational restructuring. And finally, for me, slide 15. This slide summarizes our financial guidance for the first quarter. Traditionally, our lowest sales and profitability quarter, and typically a quarter where we use cash. Before diving into numbers as a reminder, relative to other quarters, last year's first quarter sales and adjusted operating profit were most significantly negatively impacted by COVID, notably in APAC. Even though it is challenging to specifically quantify the exact year-over-year COVID impact, since COVID still presents headwinds in parts of our business today, Clearly, last year's first quarter is the easiest comp of the four quarters. With that in mind, we expect 13 percent organic growth from the first quarter of last year. Our adjusted operating profit is projected to increase $55 million at the midpoint, and adjusted operating margin is expected to increase approximately 500 basis points. Adjusted earnings per share is expected to be approximately $0.11 at the midpoint, up $0.76 from last year's first quarter. This year-over-year quarterly earnings per share increase includes a $0.54 benefit from two discrete items in the first quarter, including the $174 million loss on extinguishment of debt and $21 million of SPAC transaction costs. In addition, interest expense in this year's first quarter is expected to be $45 million lower than the first quarter of 2019, driving an additional $0.13 per share adjusted EPS benefit, a year-over-year benefit that does not repeat as significantly over the remaining three quarters due to the timing of the SPAC transaction and debt refinancing last year. With that said, I turn it back over to Rob. Thanks, David. Turning to slide 16, I wanted to provide some color on the key themes and initiatives we shared with you on our earnings calls over the past year. First, our focus is on the top line. We continue to strengthen all of our customer relationships, but especially with providers in the cloud and co-location space. Doing so has led to order increases in 2020. While large projects with cloud and co-location customers will always ebb and flow, we are gaining greater visibility into the future needs of our customers, which will translate into our ability to meet future demand and win projects down the road. Furthermore, we continue to hone our go-to-market efforts in the IT channel area. We saw the greatest traction occur in the United States, and the impact got stronger as the year went on. Secondly, we are piloting the Vertiv operating system known as VOSS, in two of our manufacturing facilities. Already, we are experiencing improved performance and favorable results as we formalize and standardize the way we work. The raw globally, as we've said, will take time, but I'm pleased with the early results that we're seeing. David talked about margin expansion in his comments, and I'm very pleased with our performance in this area. Our sourcing capabilities have continued to improve. Our pricing initiatives have continued to yield favorable results, and our restructuring actions announced last quarter are now in full flight. The foundation we have established and the trajectory that we are on gives me confidence in our ability to achieve the expansion plans we laid out a year ago. Finally, and maybe my personal favorite, VPE, our Averted Product Development Progress. We continue to focus and fund our research and development programs. Even though we couldn't or had limited travel in 2020 imposed because of COVID, we still conducted the verdict user experience view sessions to bring us closer to our customers and help us become more stronger strategic partners for the long term. We have seen the pace of new products and service introductions increase year over year. And in 2021, there'll be no difference. In addition to these real-time results, we have also started to do some seed planning in a few future targeted areas to ensure we continue to be on the cutting edge in our industry. Now turning to slide 17. I'm very proud of the VERDICT team and what we've accomplished over the last 12 months. We delivered on our commitments. We demonstrated we are a great company and a growing industry. We have executed on many key activities which have implemented many strategic initiatives which will serve us both well in the short term and in the long term. To all of our employees on the call today, thank you for the dedication and tireless effort to take care of our customers. To all of our investors, thank you for your support over the past year and being with us on today's call. I'll now turn the call over to the operator who will open up the line for questions. Thank you.
spk08: I'll begin the question and answer session. In order to ask a question, press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the compute in A. First question comes from Jeff Sprague of Vertical Research.
spk10: Thank you. Good morning, everyone. Hey, yeah, I think the, you know, the change in the reporting actually will be positive over time and simplify things. There's a fair amount of confusion here this morning, but from what I can tell, We bridged to something pretty close to where consensus was. So thanks for all the restates. I wanted to talk about the normalization of cash flow a little bit, if we could. And I understand there's, you know, there's some pressure here in 2021 as you lay out in the bridge. You know, we end up with free cash flow in 2021 that's, you know, on the low side relative to adjusted EPS or EBITDA or revenues. And I just... One of your views, if you could give any context on, you know, once we work our way through 2021 here, some of these items normalize, how you would kind of frame up the kind of the ongoing through cash flow picture.
spk11: Yeah, thanks, Jeff. This is David. And thanks for the feedback. So I would point out two things in 2020 cash flow that are, you know, somewhat anomalistic. So The first and most significant is the cash required for restructuring. So we had anticipated to have approximately a $60 million cash outlay in 2021 for restructuring programs. Our current estimate is closer to $70 million, and $50 million of that is embedded in the restructuring cash payments bridge item on slide 14. And then we have another 10 to 20 million included in adjusted operating profit for 2021 projects. So that's about a 70 million cash outflow. We'll always have some outflow for restructuring from a cash basis, but that's probably high by a good $50 million. The other item I point out is CapEx. I think historically we've kind of provided go-forward direction of CapEx in the $75 million range. We're guiding to 95 next year. And a lot of good projects are included in that 95, but it also includes some projects that were pushed from 2020. So if I were doing a model, I probably would include 95 going forward, but I would include more than 75. My guess is that we will settle in right around $85 million. All the other items, including cash interest, if anything, that should decline going forward. Cash taxes probably will increase. You know, working capital is one item that we still have a lot of work to do, and we see some opportunity going forward. But other than restructuring and CapEx, I would say 2021 is somewhat normalized.
spk10: Great. Thanks for that. And just one other one for me, and I'll pass it on. On the enterprise-related activity and I guess the small signs of some additional life that you commented on, Can you provide any additional color on your visibility there? You know, can you see a pipeline developing and kind of, you know, bid and proposal activity? I just wonder if you could put a little bit of kind of firmer point on that for us.
spk11: Yes. Sure. Hi, this is Rob. Yeah, what I'd say is we always talk to the fact that we take a look at Our pipeline growth, that's always the leading indicator, and even that is pre-activity on quoting, as you mentioned, which is exactly that. We've seen pipeline expand exiting out of 2020, so that gives us some comfort that the enterprise will begin to recover. Activity is intense in the design area with both electrical and mechanical contractors. So, again, that gives me reason to believe that we will see that recovery. It's just a matter of, you know, if and when, not if, but when people kind of get out of this COVID thought and start spending again. But the activity looks good and gives me confidence. And that's globally. And we've seen probably a quicker recovery on the enterprise in, let's say, Asia, and Europe is spotty, and then America has probably been the slowest. But overall, the pipeline looks good, and the activity is – we're very active there.
spk08: Great. Thank you. Your next question comes from Nicole DeBlaze of Deutsche Bank.
spk02: Yeah, thanks. Good morning, guys.
spk08: Good morning, Nicole.
spk02: Maybe we can start with the outlook, thinking about, you know, normalizing towards contribution margins beyond 2022. There's obviously still quite a bit of noise here in 21. So, you know, when you think about sustainable levels of restructuring in this business, are you guys going to be factoring in like $20 million or so a year on an ongoing basis? And I guess... you know, similarly, is R&D kind of getting to the point where you're reaching your medium-term run rate, or do you think that there still needs to be a step up in R&D beyond 2021?
spk11: Yeah, thanks, Nicole. This is David. I'll certainly address the restructuring question, and I'll ask Rob to address R&D. You know, our plan at this point, especially as it relates to the vert of operating system, is related to continuous improvement. Whether you can equate that to continuous restructuring, I think that's probably semantical, but we will continue to invest dollars going forward to take dollars out of the business. I wouldn't want to specifically commit to a dollar amount per year. I think we mentioned uh, for 2021, we're investing an additional $20 million, um, on top of the 2020 restructuring program. Um, that's probably a good starting point, but, uh, if there are projects out there with returns, you know, we, we, you know, potentially could invest more than that. If there's a, um, you know, aren't projects in any particular year, it could be a little bit lower, but, uh, I think that $20 million probably is a good starting point. And as it relates to R&D, I'll pass it off to Rob. Yeah, and, Nicole, you know, as part of our stated strategy, and we talked about it on the roadshow, we plan to take R&D up to 6%. Innovation is our vector of differentiation and will allow us to get that margin expansion, and there's a lot of co-adjacencies and other areas that we can participate in. So what we expect, while you've seen a fairly large ramp, to catch up to that 6%. We expect 6% of revenue going forward to be in the R&D space so that we can be that innovative leader and look at other adjacencies as well. We expect that that will produce long-term results over time. R&D does take a little while. Some of our products in the channel space will see benefits within the year. Some of the larger projects we see within 12 years. to 18 months, but we're very excited about the opportunities. We have more R&D projects, I would say, than we have funding. Our collaboration efforts have proven to be successful with the COBRA and Hyperscale, allowing us to design in and drive a better margin profile.
spk10: Got it. That's great, Paul. Nicole, this is Dave, just kind of maybe putting the two points together. At the end of the day, we're sticking with our strategy to grow sales and hold fixed costs constant. And that creates a lot of room for both margin expansion and reinvestment. So we still plan on doing both, not just in 21, but long into the future.
spk02: Got it. Thanks, Dave. And then just for the follow-up, what have you guys embedded for pricing for 2021? And I guess, you know, further to that, is the expectation that you can offset recent raw material inflation with pricing, or is there any sort of price cost headwind embedded in the guidance?
spk04: Yeah. Hey, Nicole. Good morning. It's Gary Niederprum. So I would say if you reflect back on pricing for 2019, we had a pretty good year. I think we've told everybody we were about $20 million to the positive. In 2020, we were somewhere in that $15 to $20 million range. And our expectation is that for 21, we will have positive price as well. Certainly some headwinds coming from commodity and inflationary aspects all around the globe. But we feel pretty good about where we sit right now to continue passing price along, whether it's going to be in the same range of what we're able to do in 19 or 20. Not quite sure just yet, but we'll certainly be on the plus side of that equation from where we sit today.
spk02: Got it. Thank you. I'll pass it on.
spk08: The next question comes from Scott Davis, Mellius Research.
spk09: Everybody?
spk08: Good morning, Scott. Good morning, Scott.
spk09: I didn't hear anything and didn't expect to hear anything on M&A and your prepared remarks, but it's worth asking the question. You're delivering pretty quickly. Is there an opportunity to start to play offense perhaps on bolt-ons and perhaps even stuff that's a little bit larger than what you've historically looked at?
spk11: Sure. Hey, Scott, thanks for the question. Our stated strategy and what we talked about when we were out raising the pipe was we do have a robust list of potential targets that could be nice bolt-ons for adjacencies or completing a global product line. We'll continue to look at those, and if it makes sense. It hasn't been our first priority. Our first priority was to pay down debt and look at – acquisitions as something as opportunistic as they come and like Dave Cody's always said they don't always present themselves when we want them to but we continue to look and follow and track those companies that we might be interested in but again it isn't our first priority to go out and buy something we do like the optionality that we have today with the strengthening of our liquidity to be able to look at various things but we just have to take those as they come
spk09: Okay, fair enough. And then just to be clear on the capital spending side, is it, you know, when you think about your spending, and I imagine there's a mix here of things you're spending on, but is it more weighted towards new capacity or kind of tuning up, upgrading, you know, IT spend, et cetera, on existing capacity?
spk11: Yeah, this is David. So I would say it's probably split in three different buckets and certainly not equally split. But we are continuing investment in IT. And that's something that, you know, we'll be launching an ERP system in the Americas in 2021. And that takes, you know, continued capital. operational, you know, it's probably a little bit over a third of the overall spending. Some of that is, you know, continues to be maintenance spending, but also related to some of the restructuring that we announced last year. And that CapEx will be more skewed towards the back half of 21, and we'll see benefits from that in 2022. And the last bucket is related to, you know, divertive product development or R&D initiatives. And, you know, that's something could be in a range of $20, $25 million that we would anticipate to continue going forward. So, you know, overall, as I mentioned to Jeff, the 95 for this year probably is a little bit elevated. But, you know, this spending, most of it is investment related, meaning there is a return. as opposed to just continuing maintenance capex.
spk09: Okay, super helpful. Good luck, guys, in 21.
spk08: Thanks, Scott. The next question comes from Nigel Coe of Wolf Research.
spk07: Thanks. Good morning, everyone. So just curious on the switch from EBITDA to EBITR effectively, does that map to a way that you're changing internally in the way that you're measuring and compensating, you know, execs internally or just like a change in presentation for us folks? And, you know, I do think that, you know, some investors are struggling to, you know, compare like the likes. So Just on that regard, it looks like there's about $70 million in expenses that would have been added back in FY20, stock-based comp, transmission costs, and restructuring. Those are three buckets I can see. If you could just confirm that in about four parts, that would be helpful. Thanks.
spk11: Yeah, this is David. So, Nigel, what I can say is that The way we report to the street is going to be exactly the way we scorecard ourselves internally. So we had used adjusted EBITDA for internal basis for measuring and compensating, and we are definitely transitioning that to adjusted operating profit as well. On a go-forward basis, if you were to look at 2021, adjusted operating profit versus what we had included for adjusted EBITDA for 21, so the 660 versus the 575, that difference is simply depreciation. So on a go-forward basis, effectively what we're doing is holding ourselves accountable for capital spending and the resulting depreciation going forward. So, of course, I think a lot of the confusion comes looking at the historical and some of the historical adjustments. But going forward, the only difference between adjusted EBITDA and adjusted operating profit is going to be that depreciation. And, of course, very critical is not having any adjustments going forward. So we're holding ourselves fully accountable for any expense that hits the P&L. And the only adjustment from GAAP is going to be that intangible amortization.
spk07: Right. What I'm saying, what the question was, if we were in FY20, just so the investors can compare like-for-like and get an underlying incremental margin, it looks like $70 million of costs are being fully absorbed in the FY20 on-plan that would have been at a back ordinarily. Is that the right zone?
spk11: I think that is directionally fair you know certainly um if you look at a couple of the items that i mentioned um related to slide 13 we will have 25 million dollars of stock compensation costs in 2021 that is a cost that in 2020 was treated as a historical head back in addition we have about 25 million dollars of i.t related expense um that historically we, uh, and these are implementation costs related to, uh, new projects, um, that $25 million would have been included as an ad back for 2020. So that that's $50 million, uh, you know, right off the bat, um, you know, the 20 million additional that you're referring to, I believe is restructuring expense. And, um, You know, that is something if you compare it to the $70 million historical ad back from the third quarter last year also would have been treated as or be subject to be treated as an ad back. So if that's how you're developing the $70 million, I would agree with that math.
spk07: That's exactly right. Thanks, David. That's helpful. I mean, a quick one on the $65 million investment spending. Where does that take R&D? I know R&D targeted 50% of sales, but where does that mark to market R&D as a portion of sales in 2021?
spk11: Yeah, so, and we'll be filing our 10-K on Monday. Our R&D expense for, and we'll disclose R&D expense, but our R&D expense for 2020 was $230 million today. which was about 5.2% of sales. That $65 million figure on slide 13, about half of that is R&D, and the other half of it is based on growth initiatives. So assuming an additional $30 million spend and the 4775 guidance for next year takes R&D as a percentage of sales up to close to 5.5%. Okay. Thanks, David. Yep.
spk08: Your next question comes from Amit Dari-Anani of Evercore.
spk06: Thanks for taking my question. I guess I have two as well. First off, when I think about the $65 million of incremental expenses in calendar 21 that are being made, can you just talk about how do you think about payback on these investments? Do I think about Vortis' inherent growth being better in the calendar 22 and out here, or do I think about a step up in conversion margins? How do I think about that payback on these investments over the next few years?
spk11: Sure, Matt. Hi, Rob here. Yeah, what we've said on these investments is that, as I mentioned earlier, some of the projects take a little bit longer than others, but the reason for investing is so we can outpace the actual market growth. So by investing in these new product categories or new product areas, It will accelerate our growth that, you know, one and a half times the market growth rate. And those things happen over a period of time. Channel-type products, more IT-based products, you know, six to 12 months, we began to see a payback on those. And then the larger products, typically 12 to 18 months, and you begin to see the sales on those. And they could be things like larger products. UPS, larger megawatt UPSs are larger cooling or thermal management units. Those things take typically a little bit longer to get out globally, but it will yield over the next several years our ability to outpace the market growth rate.
spk06: Got it. And then just as a follow-up, when I think about your web scale, your hyperscale, colo, customer base, can you just touch on, you know, do you think you are at this point over or under index or market share basis in that bucket? And what are the steps you can take to drive up your sharing in this market over the next few years?
spk11: Sure. So we always – great question. We always kind of combine colo and hyperscale because, as we've talked about in the past, Outside the U.S., the hyperscalers typically work with colocation companies for their data center builds. And inside the U.S., they typically build themselves. And then there's a mixture of that. I would say there's room for growth in both. You know, if you just look at our overall market share, we have the ability to grow, and we think our collaboration method and model, working closely with our customers to design those products, will give us the ability to take additional share. We had some very nice wins in conversion in 2020 of maybe some co-location companies we haven't worked with in the past. So we think there's plenty of room for growth, and as the expansion happens, on a global basis, you'll see that the opportunity is there. We don't necessarily sell our full entire product set in all of the hyperscalers today, so there's room for improvement there as well, whether it's a larger battery backup system or a larger SDS or more power distribution. There's room for growth there, too. So we're certainly not at a saturation level and have the ability to continue to grow our share there. And that's one of the reasons why we're investing in R&D so heavily.
spk06: Perfect. Thank you very much for your time.
spk11: Thank you.
spk08: Your next question comes from Lance Vintanzo of Collin. Hi, thanks, guys, for taking the questions.
spk11: First off, the revenue performance and the revenue guidance relative to the industry growth that you discussed in the past, I guess you're taking significant market share. So my question is, where exactly are you seeing these gains? Is this mostly from taking business away from the smaller companies that we necessarily haven't heard of, or are you also taking share from the Schneiders and the Edens of the world? So great question, Lance. Thank you. This is Rob. What I'd say is a combination of both. When we look at some of the share gain that we're seeing, certainly there's a lot of regional players, smaller regional players that we compete against. And because of our global nature and filling out some product gaps that maybe we had, we're able to take that. But, you know, I think as it relates to Eaton Schneider, you know, we compete with them, and it's different in every region, right, how competitive they are or they aren't. But I would say in general we believe we're growing in both cases and taking some share. I know, you know, just looking at some of the channel statistics in the IT channel side of things, While a lot of people were down, I think our overall decline in 2020 was much less than our competitors in some cases, therefore showing that we took some share there as well. So it's kind of a biggie in the channel and in the co-location hyperscale. Great. Okay. And then my other question is actually with respect to slide 13. I wanted to focus on this 26%. projected increase in adjusted operating profit. That's the metric that we're going to be looking at going forward. So I think that's where we want to focus. And I guess the question is, what should we think the potential there is for that kind of growth to be sustained beyond 2021? I'm not asking for guidance. But I'd love to get your thoughts there. And if nothing else, perhaps we could talk about the $40 million of COVID savings that are sort of being restored in 2021. Well, clearly that, I would think, that's not going to be recurring in 2022 and beyond. On the other hand, it does sound like the growth in the R&D investments are going to continue to increase for the next several years. But that being said, you know, I mean, how should we be thinking about the kind of that 26% growth? Is that an anomaly or, you know, just indicative of what the earnings potential is for this business? Yeah, this is David. I'll take a shot and then pass Rob the comment as well. So, One thing that I do want to reaffirm for everybody on the call and all investors and analysts is that we are still fully committed to the margin improvement goals that we have talked to historically. So just because we're switching to adjusted operating profit from adjusted EBITDA, it doesn't change the intermediate and long-term impact goals that we have for margin expansion. Now, we will have to recalibrate. So I think we historically have talked about getting to 17% adjusted EBITDA. And I think an equivalent number for adjusted operating profit is somewhere between 15% and 16%. But we're committed to using 16%, you know, for that intermediate goal. And, you know, And there's no reason we can't get to 20% in the long run. So I think we've used that as kind of the long-term hurdle. That has not changed with this transition to adjusted operating profit. And so I think that very much works into your question about the future expectations for adjusted operating profit growth. Certainly we see the growth in adjusted operating profit being enhanced and growing with the top line. So as long as we continue to grow that top line in, you know, above market while expanding, you know, margins, there's no reason mathematically that we can't continue similar growth going forward. Thanks very much, Nathan.
spk08: Your next question comes from Andrew Obin, Bank of America.
spk10: Andrew Obin, Bank of America. Good to be laying on for Andrew Obin. I wanted to ask about what your guidance assumes around the services revenue, given that you're still having site access issues here in, I guess, January, February.
spk11: Yeah, hi. I'll take a first stab at that, and then David finish that off. But, you know, we – We will continue to deal with COVID. COVID, you know, is an issue with site access. But we expect, you know, that year over year we've got in the plan that we will be growing our services revenue as part of our overall growth strategy. Could be overall COVID. We can't predict what that looks like, but we've been able to navigate pretty well around that. There's just various areas and hot spots that we'll have to deal with from time to time. But we do expect to have, and built into our plan, is growth in the services for 2021. Got it.
spk10: And then as a follow-up question, Maybe could you talk a little bit more about what you're seeing in the enterprise space? What are the areas that you're seeing the improved demand, and what's still weak?
spk11: Yeah, I'd say it's going to be by industry vertical, right? We're still seeing, of course, travel and entertainment being one that hasn't recovered and not sure when that will recover. Certainly other verticals like retail, big box stores, we've seen the spending begin there as people continue to compete for that kind of retail local distribution. Certainly on the financial vertical, we see spending beginning to pick up there in the financial space. And then the other areas of positive signs is around education and government spending would be the other ones that we would see from there. So while some sectors are down, in general, those are kind of the areas that we're seeing some bright spots in today. Perfect.
spk10: Thank you very much.
spk08: Thank you. Your next question comes from Mark Delaney, Goldman Sachs.
spk05: Yes, thanks very much for taking the questions. First, I was hoping to dig into the demand environment a little bit more. The company reported very strong backlog growth of, I believe, 32%, and that's now at a high level. As you're thinking about the backlog into 2021, do you think you're going to be able to sustain backlogs at this type of a high level or perhaps even grow it, or would you think you're potentially going to work the backlog down a little bit this year?
spk11: Hi, Mark. I'll start and then let David come in. We're seeing and continue to see strong demand both in Q3 and Q4. If you listen to both hyperscale and co-location, their business is going quite well, and that's a big driver in driving our backlog on projects. I think our global expansion that we're seeing in China, in the telecom side of things, certainly India now has come on the radar map for hyperscale and co-location. So I guess what I'd say is we expect upper single-digit growth in the order rates and expect to continue to see that to happen.
spk05: That's helpful. Thanks. And my follow-up question was on the channel opportunity. And, Rob, you mentioned a few times throughout the call about some strengths that you're seeing in that market begin to materialize. Is that more a function of the macroeconomic environment and some of those types of customers coming back, or would you attribute it as well to some of the company-specific efforts that Vertiv has underway to better penetrate those channel customers?
spk11: Yeah, great question, Mark. No, I attribute it to kind of the execution and some of the programs and some of the products that we brought out. We've got some unique products in our power distribution, IT power distribution side. We've been pretty aggressive on our lithium ion offerings and making sure that that's available. some of the programs that we've targeted are paying off. And we've had, as we mentioned, quarter to quarter. Year over year still was down, but quarter to quarter, we've seen the improvement. So we feel like we're on the right trajectory with both new product intros. The programs that we're offering, we've certainly simplified our partner portals, project registration, being that hopefully easier button for our customers to come diverted for that. We're taking that same and we've kind of globalized that same strategy to Europe, which is a little bit further behind, and then driving it into the rest of Asia and China. So As you know, this is a big part of our strategy. This does take time. We've chosen to do it organically, but we believe that our current strategy and trajectory will yield the results ultimately that we're looking for. Thank you.
spk08: Again, if you'd like to ask a question, press star then the number one on your telephone keypad. Your next question comes from Andy Kaplowitz of Citi.
spk01: Good afternoon, guys. Good afternoon, Andy. Can you give us a little more color into the continued strength you're seeing specifically in EMEA? You've been talking about working on some large co-location projects for a while now. These projects continue through 21, and I know in the past you've talked about regional data sovereignty driving growth. So how sustainable are these trends there, and what else is going on in the region that's leading to such good performance in EMEA specifically? Absolutely. And great catch on the EMEA side of things.
spk11: What we see typically with hyperscale and COLO is typically rushing to various parts of the world. And so there'll be, well, let's say maybe not as much spending in the U.S. going on or growth. We have seen that. And I firmly believe that data sovereignty, people want data centers in their country. Governments want that data there. They don't want it sitting in data centers in the U.S. nor in China. So I think there's a lot of build-out. If you take just a look at the number of data centers, number of cell phone users, number of broadband access in Europe versus what you've got in the U.S., I think we have a lot of runway ahead of ourselves as it relates to Europe and the builds that still have to happen there. The Brexit thing has driven lots of data center builds and parts that we didn't think were necessarily going to happen. So we continue to see strength, I think, over the next couple of years in the European side of things. We have taken some share there. We've had some new customers that we haven't traditionally done business with in the past. So the customer acquisition has been good there. But I'll tell you, if you look at globally, I'm pretty excited about, you know, whether it's Europe or Middle East and Africa, South America. Again, a lot of chatter and talk in India around co-location hyperscale finally coming there. They're so underserved. So I think we've got a lot of runway. other parts of the world, plus what's still happening here in the U.S. Not that the U.S. isn't going to grow. It's going to continue to grow. But I think we'll see outside Europe's leading the way now. But I think you'll begin to see some of the Asian
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