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spk06: Background noise. Please note that this call is being recorded. I would now like to turn the program over to your host for today's conference call, Lynn Maxeiner, Vice President of Investor Relations.
spk04: Great. Thank you, Anthony, and good morning, and welcome to VRTIS' third quarter 2021 earnings conference call. Joining me today are VRTIS Executive Chairman Dave Cody, Chief Executive Officer Rob Johnson, Chief Financial Officer David Fallon, and Chief Strategy and Development Officer Gary Niederprun. 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 VRTIS. 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, our annual report on Form 10-K, 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. On 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.birded.com. With that, I'll turn the call over to Executive Chairman Dave Cody.
spk12: Good morning, everyone. The current environment we're operating in is certainly a challenging one. I can't remember a time analogous to it. You can see from the press that demand remains strong in almost every end market, and ours is very strong, especially with our new product initiatives. In the short term, we have to continue to fight the battles for component parts to support our customers. And we need to get ahead of the price inflation curve that Rob will tell you more about. While this is a painful and an irritating time to deal with, it is what it is. And I can assure you, we will come out of this admirably, especially given our investments in the long term. We're obviously interested about the ENI acquisition, which we will do very well with. Gary and I were down in the ENI facility in South Carolina a few weeks ago with Phil, brainstorming and reviewing the cost and revenue synergies we know we can create over the next several years. In addition to the synergy review, we discussed the investments we can make in further products and services, process improvements, people, and systems that will pay dividends over the medium and long term. There is a lot happening in the business that portends a superb future. So while we continue planning and executing for the future, we recognize we also got to get to the current situation and do everything we can to continue supporting our customers, which we will do. So with that, I'll turn the call over to Rob. Rob?
spk11: Thank you, Dave. The reviews that you continue to conduct with me and the team always leave us in a better place. and our business is actually in a much better place because of your involvement. So all of you on today's call, thank you for being here. I'm eager for you to hear more about our 2021 third quarter performance, our outlook on the market, and an update on our portfolio. There are six key messages I want to convey today. First, as Dave mentioned, demand for verted products and services remain strong. During our last earnings call, we reported second quarter sales were up more than 25% and orders were up 24% compared to the second quarter of last year. I'm pleased to report that sales and orders are up again in Q3. Sales were up 6%, which is very much in line with the guidance we provided in our last update, and orders were up 17%. In addition, our Q3 backlog rose to $2.4 billion, the highest it's ever been. Second, profitability is up. This quarter, our adjusted operating profit was 131 million, up 64 million from last year's third quarter. This resulted in adjusted operating margin expansion of 490 basis points. Third, year-to-date free cash flow is greater today than it was this time last year. Free cash flow for Q3 was 44 million, and year-to-date is 128 million. From a year-to-date perspective, this represents an improvement of over $140 million versus the first three-quarters of 2020. Fourth, as Dave mentioned, we are dealing, like others, with supply chain and inflationary issues. We encountered supply chain challenges in Q3 and experienced commodity and freight inflation. We made spot buys so that we can meet our delivery commitments we made to our customers, and we have implemented strategies to recapture those costs. Pricing always lags costs by a few quarters, and that's exactly what we're seeing now. However, we believe, as we've mentioned before, pricing will be a tailwind in 2022. Fifth, we expect to close the E&I acquisition by November 1st, which is a month earlier than previously communicated. In addition, we've signed an agreement to sell our heavy industrial UPS business, and we expect to close that transaction by the end of Q4. And the final key message is we are confirming our latest guidance for the burden base and slightly increasing our guidance for the impact of the M&A transaction. Turning to slide four. This is the chart we use to illustrate what we're seeing in each of our world regions in each of our end markets. In the cloud and hyperscale co-location markets, they continue to remain strong as evidenced by the green buttons. The demand for digital continues to fuel the industry and is driving a strong and growing need for product and services. In our enterprise and small to medium business market, we continue to see signs of progress. Enough progress is made in America to upgrade this segment from yellow to green. We continue to experience an increase in the pipeline and orders with America's leading the way. The communication networks had a few moments. We saw 5G deployments in earlier parts of the year being very robust and began to see that slow or a digestion over the last quarter or so. We've experienced Europe beginning to deploy 5G, and we see consistent deployment in Americas. In the commercial industrial markets, things remain consistent. While this is a smaller size of our business, the variety of products and services we sell here continue to expand. Moving to slide five. As referenced in my opening slide, our order rates continue to be robust. Our Q3 order rates were up 17% over Q3 of 2020, and on a year-to-date basis are up 21% versus the same time period last time, with cloud and co-location segments leading our way. Virta's executive team remains closely connected to the accounts, and we're seeing the strong demand continue. Because of the deliberate connections we are making, we are gaining further visibility into customer demand, leading to advanced orders and insight to their future pipelines that we haven't seen in the past, which is a tremendous help in our demand planning as we go forward. This and other actions we are taking have led to a record backlog, as I mentioned earlier, of 2.4 billion, which is 34% higher than our backlog was at the end of 2020. As you heard from Dave in his opening comments, supply chain continues to pose challenges for us and many, many others in the industry. Each of the regions are experiencing it, but it is most acute in Americas where material availability is most difficult and commodity prices have risen beyond expectations. Where necessary, we'll continue to use spot buys so that we can take care of our customers. From a pricing standpoint, we are in line with our prior guidance we provided for Q4. We'll continue with pricing actions throughout 2022. Moving to slide six. When we spoke last, we expected to close the E&I deal by December 1st, but I'm very pleased that we'll be able to close this deal a month earlier due to the diligence of the combined Vertiv and E&I teams and with help from our transaction partners. We had a successful debt raise a few weeks back, and all antitrust hurdles have been cleared. The market reaction has been overwhelmingly positive. Gary, Phil, our regional presidents, I have been on the phone with hundreds of customers, and the receptivity to the deal is exactly what we wanted. Very optimistic and very excited. Integration planning has started right after the deal was signed, and I look forward to entering into the execution mode in a few days. While ENI orders remain very strong, they are facing site readiness and supply issues on electrical components no different than others in the industry. Now, let's turn to divestitures of the heavy-duty industrial UPS business. We have signed an agreement to sell this business to a financial sponsor called InnoFonds. InnoFonds will retain the existing management team, which makes for a very easy transition and provides for great customer continuity. We expect this transaction, as mentioned earlier, to close by the end of Q4. With that, I'll turn it over to David to take a closer look at the Q3 numbers, and we'll come back with some final comments at the end. David? Great. Thanks, Rob. Turning to page seven, this slide summarizes our third quarter financial results. Net sales were up 67 million, or 6%. 4% when adjusted for a $20 million foreign exchange tailwind. However, our third quarter top line was negatively impacted by continued challenges with procuring electronic parts, as underlying market demand is much stronger than implied in our year-over-year quarterly sales growth. The strong underlying market demand was evident with third quarter orders, as Rob mentioned, which were up 17%. after increasing over 20% in the first half of the year. Adjusted operating profit of $131 million was just above the midpoint of our guidance range, and increased $64 million, or 94%, from last year's third quarter, which included an $80 million charge for restructuring and an asset write-off. Contribution margin in the third quarter continued to be negatively impacted by material and freight inflation, which outpaced our pricing by approximately $40 million in the quarter. We expect to further narrow the imbalance between inflation and price in the fourth quarter and expect net price inflation to be favorable for full year 2022 as a result of incremental pricing actions in the fourth quarter and into next year. adjusted operating margin of 10.7% with 490 basis points higher than last year's third quarter, but approximately 200 basis points lower when last year is adjusted for the restructuring and asset write-off charge.
spk01: And this year-over-year reduction is driven entirely by net inflation. Finally, on this page, free cash flow of $44 million was approximately $85 million lower than last year, and we will address the components of that delta in just a couple slides.
spk11: But despite this quarterly unfavorable variance, year-to-date free cash flow of $128 million is still approximately $140 million lower
spk01: the Americas region continues to face supply chain challenges to other regions due to regional differences in the pace of material inflation and availability of electronic parts.
spk11: These supply chain challenges negatively impacted both America's top and bottom line, with net sales up just $5 million, or 1%, against the strong market backdrop and adjusted operating margin was down approximately 400 basis points driven primarily by net inflation. Moving to the right, APEC net sales were up approximately 4 percent but relatively flat on an organic basis as last year's third quarter benefited from China government investment in several telecom and wind power programs.
spk01: Third quarter adjusted operating margin in APAC was up both before and after adjusting for the $11 million restructuring charge in last year's third quarter.
spk11: EMEA continues to pose very strong financial performance with net sales up 19% from last year's third quarter and adjusted operating margin was up almost 300 basis points after adjusting for last year's $41 million regional restructuring charge. And although not immune to the effects of net inflation, the EMEA supply chain environment, at least to date, has been less disrupted than the other two regions. Next, turning to slide nine, this chart bridges third quarter free cash flow from last year. down about $85 million to $44 million. The most significant negative variance is driven by a $43 million inventory build in this year's third quarter, in part due to several large project delays and the strategic stocking of certain electronic parts to protect future customer deliveries. CapEx was approximately $10 million higher this year versus last year, and certainly last year's third quarter was negatively impacted by certain COVID constraints. On a year-to-date basis, free cash flow is up $128 million, and we reaffirm our full-year free cash flow guidance of $205 million today. which includes approximately $45 million cash outflow for M&A transaction expenses. Next, turning to slide 10, this page summarizes our M&A activity plus the expected impact of the E&I UPS business divestiture. For avoidance of doubt, we exclude M&A transaction closing and other expenses in our financial results and guidance, $18 million in the third quarter, which includes a $9 million impairment loss for the sale of the industrial UPS business, and $51 million in the fourth quarter for $69 million total transaction expenses for the full year. And we summarize our non-GAAP treatment of these expenses in the reconciliations in the appendix to this presentation. Our base VERDAS net sales guidance is up approximately $35 million from our previous guidance based upon improved visibility of our supply and shipment schedules in the fourth quarter. We've also added $55 million incremental net sales
spk01: from M&A, $10 million reduced sales from the industrial UPS business divestiture.
spk11: As Rob mentioned, when we announced the E&I transaction at the beginning of September, we anticipated a December 1st closing date and $45 million of incremental fourth quarter revenue from E&I. Now with the acceleration of the anticipated closing date to November 1st, we expect $65 million of incremental E&I revenue in the fourth quarter.
spk01: Adjusted operating profit for base verta is materially in line with our previous guidance at $540 million.
spk11: with the benefit from higher net sales offset by higher expected versus our early September guidance. We have added approximately $13 million in operating profit to our guidance for M&A, and that includes $15 million for E&I, assuming a November 1st closing date once again. And that $15 million is offset by approximately $2 million from the sale of the industrial UPS.
spk01: This year's fourth quarter net sales are expected to be up 8%. Adjusted operating profit up 16%.
spk11: with 90 basis point improvement in adjusted operating margin. Adjusted EPS is expected to be down approximately two cents per share, but the year-over-year comparison certainly is negatively impacted by the timing of income tax expense in this year's fourth quarter, which is uh, artificially high due to the quarterly treatment of, uh, some non-deductible losses from the changes in, in the fair value of the, uh, warrant liability. Uh, next, uh, turning to slide 11, we summarize, um, our, uh, full year 2021 financial guidance, which includes base verdict and provision for the MNA activity. Full-year net sales are expected to be $5 billion for the full year, and that's up 14% from 2020, including M&A. And the adjusted operating profit for 2021 is expected to be $553 million, still up 22% when adjusted for the $113 million
spk01: of 2020 pro forma items.
spk11: Our full year adjusted operating profit guidance for base vertib is unchanged and adjusted operating margin for the full year is expected to be 11.1%, up 330 basis points from 2020 and still up 70 basis points when adjusted for 2020 pro forma items.
spk01: From previous guidance, And once again, this includes expected M&A cash transaction and closing expenses. So with that said, I turn it back over to Rob. Well, thanks, David. I want to provide an early glimpse of 2022, which we're really excited about.
spk11: From a top-line perspective, we clearly enter the year with a backlog that's significantly higher than what we came into in 2021. And from my view right now, the backlog will be approximately $500 million higher than previous. As discussed on the earlier slides, our markets continue to show strong demand for our products. All signs are pointing to cloud and co-location markets remaining robust globally, And from an enterprise perspective, demand should continue at the same pace we're seeing it today. During our last few calls, we highlighted some of the verted product development initiatives we have underway. And these products only accelerate in 2022 and beyond. We continue to invest in new product development and go-to-market strategies. From a potential headwind standpoint, we're expecting to see part shortages last at least through the first half of next year. We also know customers are dealing with trade labor shortages and difficulty in getting some of their key building materials that they need. While it's difficult to predict the exact impact on us, these are very real issues, and our customers are dealing with them on a day-to-day basis. As for profitability in 2022, we expect pricing will be a tailwind. We will have a full year of E&I in our results, which will be accretive. We will continue to deploy the tenets of VOSS, fixed cost constant, and as mentioned earlier, still funding incremental R&D and growth initiatives. We do expect inflation to continue into 2022, but even at today's level, we are planning next year to be net positive on price. Turning to slide 13. As I close, I want you to know how proud I am of the Vertiv team and what we, together as one Vertiv, have accomplished in the first nine months. The results we've shared today are reflective of the hard work and commitment of our 20,000 employees globally, some in the factories, some in the field, some in the offices, and some still working remotely in over 130 countries. As I look at the remaining month of 2021, as we continue to invest strategically, I'm confident we will see above market top line growth, increase in profitability, and strengthening in our balance sheet. When I look down the road at 2022 and beyond, My confidence is bolstered by the conversations I've had personally with partners and customers around the globe about demand, pricing, and future pipelines. To all employees, I'm grateful for you and the part you've played in the past three months that have allowed me to provide today's earnings report. Thank you for your dedication and your tireless effort to take care of the customer. To our investors, thank you all for being on the call today. Thank you for your trust and support. It's truly my pleasure to be leading Vertiv. I'll now turn the call over to the operator to open up the line for questions.
spk06: We will now begin the question and answer session. In order to ask a question, press star then the number one on your telephone keypad. To withdraw your question, press star then the number two. We'll pause for just a moment to compile the Q&A. The first question comes from Jeff Sprague with Vertical Research. You may go ahead. Thank you. Good morning, everyone. Good morning, Jeff. Good morning.
spk12: Good morning, Jeff. Good morning. Hey, Jeff, I'm sorry, but I've got to say I certainly enjoy hearing from Mr. Sprague. Yeah, I've been called worse, Dave, you know, but how are you doing? Very well, thanks. Sorry to interrupt.
spk10: No, no worries. Good to hear your voice. first on price, if we could, and just a little more color on what you're thinking about for next year.
spk11: So your, you know, your prices, you know, it looks like it's kind of doubles in Q4 versus what you had in Q3, but I'm just wondering if you can give us some sense of how much price, you know, is in backlog at this point.
spk12: Um, and when you talk about price costs positive in 2022,
spk11: Are you talking on a – I'm sure you at least mean on a dollar basis, but I wonder if you also see it being positive on a margin rate basis. Hey, Jeff, this is Rob. I'll start first, and then David and Gary can chime in. First of all, I'd like to start off by saying that we, and it's on me, have under-forecasted what inflation was going to do, and therefore we haven't received the pricing level necessary to offset inflation in previous quarters. I can assure you going forward with our robust pricing actions and what we are doing now and will be doing in 2022, that we will be positive in price based on what we're executing on. So, again, just wanted to let everyone know on the call today that Under forecasted inflation, we understand where that's at. We're even assuming that it could get potentially worse, and we're making sure that our pricing actions now and going forward cover that. David? Yeah, yeah, thanks, Rob. Good morning, Jeff. I think if you look at the numbers and where we stand or where we expect to stand at the end of the fourth quarter is that in a do-nothing scenario, which is not going to happen, in a do-nothing scenario, the wraparound effect of net price inflation is probably a small tailwind in the $5 million to $10 million range. So, you know, we're certainly – Encouraged with what we're seeing in the price and environment here in the fourth quarter. As you mentioned, it's about a $15 million step up from Q3. But we're certainly not satisfied. As Rob mentioned, we've left some dollars on the table this year because we've underestimated inflation. And we certainly are going to be much more aggressive, and we have current plans in action to continue, you know, those price increases fairly significantly into 2022. But, you know, from a wraparound impact, looking at the numbers, a floor is probably a $5 million to $10 million tailwind. And, of course, we are – in our pricing plans, anticipating that inflation will continue to accelerate. Whether it does or not, I don't think anybody knows. But we're anticipating that it will accelerate. And, of course, we anticipate a much more significant dollar tailwind. And I appreciate your comment on the – as it relates to recapturing the margin percentage. I would say that is our intent, and we do appreciate the math of trying to do that. You could recapture the dollars but not recapture the percentages. But just to let you know, we are looking at that dynamic as well, and that certainly is our long-term goal.
spk10: Great. Very clear. And then I wonder if we could just talk about a little bit more color on then what you're seeing on enterprise.
spk11: Good to see the green dot, a little color on the magnitude of the activity there, and maybe anything you could share on the type of customer or what type of work is starting to manifest itself there. Sure, Jeff. Rob, I'll start off, and then Gary, my dad, some additional color. What we're seeing right now, especially in America, as we mentioned, is kind of a rebound of small to medium business and enterprise as they go back to work, refreshing their networks, their network closets. So we've seen that activity in the channel space for us beginning to pick up, and that's why we moved it from yellow to green. We're also seeing in the enterprise areas people reconfiguring their data centers, taking the time, projects they probably put on hold during the the pandemic, and now they're getting back to some new builds, some reconfiguration on builds as they build out their hybrid cloud strategies going forward and right-size, I guess I would say, their current data centers that will be on-prem. So that's what really gives us confidence, led by Americas. Haven't seen, you know, parts of Asia we didn't talk much about because, you know, Asia, as you know, is still being plagued on and off with COVID. We expect, you know, hopefully going into, you know, Q1 next year, Q2, that those activities, that COVID would clear itself up and we would see enterprise going in the right direction there. And in Europe... We continue to execute on our channel strategy there to drive more and more enterprise visits. But in general, corporations are spending money. They are taking care of their infrastructure now that people are getting back into the office. Great. Thanks.
spk06: Your next question comes from Scott Davis with Milius Research. You may go ahead.
spk11: Hi. Good morning, everybody. Good morning, Scott. And the tone of your comments, Rob, are meaningfully more positive than just a month ago.
spk12: I imagine that's somewhat purposeful, but that's not my question.
spk11: You kind of alluded to the reality that these projects that are being announced may get pushed to the right because of lack of labor and materials. How does that Logistically, what does that mean for you guys? Does it mean that orders get delayed and it's that simple, or does the customer, because of lack of supply, kind of want to take delivery anyways and just warehouse things so that they don't have further delays once they get kind of brick and mortar down? How does that kind of logistically work, or do we not know yet, Rob? No, Scott, absolutely, and I think you kind of nailed it. While we don't know exactly which sites are going to be impacted, what we are seeing is customers willing to take that inventory in some cases and warehouse it so they have it when that site does turn on so they don't lose their production slot or they don't lose their equipment to somebody else. That being said, that's more of a new phenomenon. And as I reach out to more of our large customers, more and more of them are wanting some type of program to have inventory. go ahead and take it off our hands and take the responsibility of it. But it's a really dynamic situation, and even things as roofing systems, which you'd think would be simple, have gone out to 44 weeks in lead time. So they are being stressed not by necessarily the equipment manufacturers. If I look at the lead times, yes, they've gone out, but not near as far as some of these other base building materials that they need for their sites. That being said, our business is a combination of, new builds and brownfields, and we feel good about that. But some of the larger projects will experience site difficulties from time to time due to trades labor and so on.
spk10: Okay. That's super helpful.
spk12: And then in the same context, when you've missed a sale over the last quarter because of supply chain, has there been instances where that sale has kind of gone away where somebody else has been able to supply it, or is the entire market just so tight that
spk11: You know, this stuff just gets moved into backlog, and everybody's comfortable with the fact that deliveries will just be a little late. Yeah, there's been spot places where we've seen somebody had to have something and somebody was willing to jump the line and maybe a competitor willing to jump the line and knock another customer out. We've been very honorable with what we've told our customers and we've not played that game. So I'd say while that's happening, it's very little. I mean, the market's tight for everybody. And we've seen, without going into detail, smaller competitors and even larger competitors. uh the commit we as you know we were one of the first companies to come out and and talk about this issue and we did it around the announcement of the acquisition because we thought that was fair and honest to let you guys know exactly what we're seeing uh but but i don't think we're penalized any worse than anybody else and the backlog will continue to grow and quite honestly, people will continue to drive further visibility, and I mentioned that earlier in my discussions. I like the visibility we're getting. The industry has traditionally not shared that because they feel it's a competitive issue because we work with a lot of competitors, to our customers, and they want to make sure. But what we're finding is building those relationships and that collaborative relationship, we're able to get even a longer view into the builds and locations, which is going to help us in the future of our planning and, you know, expansion of capacity. Helpful. Best of luck the rest of the year. I'll pass it on. Thank you. Thank you, Scott.
spk06: Your next question comes from Amit Daryanani with Evercore. You may go ahead.
spk09: Perfect. Good morning and thanks for my question. I guess I have a few as well. First of all, this $40 million of net price headwind that we have in the September quarter, I think you talked about it becoming $25 million in December. We feel confident that this should be the peak number, and as we go through 2022, that number should start to become positive. Is that the right way to think about it, and where do you see it affecting positive in 2022?
spk11: Yeah, thanks, Annette. This is David. Absolutely confirmed that we anticipate 3Q to be the peak, you know, net price inflation imbalance. And, you know, Q3 is $40 million. I think it was $25 million in Q2. We anticipate inflation to stay at the same level in Q4, but pricing can ramp up about $15 million. So that imbalance should – a drop to $25 million for Q4. And if you look at just pure wraparound effect, it would be a $10 million imbalance in Q1 of 2022. But of course, that does not contemplate any additional pricing actions. And we would anticipate to get to a point where those two elements offset one another sometime in the first quarter.
spk09: Perfect. And then if I can just kind of shift gears a little bit, and when I think about this market environment slide that you folks have, you know, it seems to us at least that some of the key verticals are starting to infect higher. I think Facebook on the hyperscale side talked about CapEx being up 65% next year in 2022. And then enterprise IT spend, I think, is equally starting to pick up as a bigger enterprise company. I guess all the data would suggest that if your lever to data center should accelerate and be better in 22 versus 21? I wonder if you would agree with that broadly, and if not, what are the offsets that we should consider with that statement?
spk11: Yeah, I would absolutely agree with what you just said, and it kind of falls in line with what we're saying about enterprise, and enterprise should be stronger next year as we begin to see the things pick up and continue to grow our channel business. As it relates to, and we get asked this all the time, what's happening? There's always been a build and fill situation where we have this absorption going on. And what's different? Why is it different now? You're absolutely right, Kolo and hyperscalers. More money is being poured into that. The utilization rates are high. What's going to be the limiting factor for the growth, not necessarily orders growth, but growth on the sales side and delivery, is going to be that material and labor shortages on probably their end. But at the end of the day, the appetite... as far as I can see out, and we typically have, you know, 18 to 24 months look ahead on the pipeline and things like that, looks very robust. And that's why, you know, I'm very bullish right now that, you know, get these supply issues behind us, which are a big nuisance for all of us, and moving forward, the market needs, you know, more critical data centers.
spk09: Perfect. Thank you.
spk06: Your next question comes from Nigel Cole.
spk05: with wolf research you may go ahead thanks good morning um i promise you no no more price cost questions so um i think that's been better quite well so the um the backlog five million dollars growth uh you know x in the year i mean just the simple math gets you you know double digit growth uh off your 2021 which I know is not the right way to think about it. But I'll ask the question anyway. Does that imply double-digit growth in 2022, just from the backlog? And then, you know, within that, are we seeing any change in China? Because, you know, the tech companies are, you know, getting defenestrated in China. So just curious if that's having any impact on their CapEx plans or capacity plans in any way.
spk11: Nigel, this is Rob. I'll stop here. Well, we're seeing a robust backlog. Again, a lot of 2022 is going to be dependent on supply and site readiness and capability. So I'm ready to commit on a 2022 number. looking at our at our backlog and the orders growth um you know it certainly would imply a robust 2022 assuming we we can deliver uh china's uh moving to china a lot of a lot of stuff in the news about what's going on with china how they're cracking down on some of the hyperscale activities um certainly the power um power outages because of the coal issues which you know has not been affecting us currently right now because we're deemed essential and we continue to run as we provide It is a dynamic environment over there. And, you know, as you know, when China decides to do something and put a stimulus in, like they did in the beginning of the year for 5G growth and some other things, we do see kind of a higher than average growth. But in general, you know, we feel good about our position, our focus on product development, being local there, and continue to grow our share there.
spk05: Great. Thanks, Rob. And then my follow-on is on the EMEA margins. You know, 19% pretty extraordinary in the current environment. And you also had, I think, a 20-handle last quarter. So just curious if, you know, number one, what's driving that margin strength? And secondly, are we moving to a new plateau in Europe?
spk11: Yeah, thanks, Nigel. This is David. So, number one, thank you for recognizing that. I would say there's two things that are driving the enhancements and margins we see this year. One is definitely centered on the fixed cost constant philosophy. So we continue to not only keep fixed costs constant in EMEA, but we've actually been able to take costs down as it relates to the investment in some of the restructuring. So we certainly uh, see a benefit there from the leverage. So with sales up as significant as they are there and, um, you know, our anticipation for the full year is that, uh, you know, they should be in that upper teens, uh, sales growth. Uh, we certainly are benefiting from, um, that, um, you know, fixed cost leverage. That's probably the primary driver. You know, I mentioned on the call that, uh, The supply chain environment in EMEA probably has been a little less disrupted than the other two regions, but they still are negative from a contribution margin perspective as it relates to net price costs. I would say most of the lift we've seen this year is because of the fixed cost dynamic.
spk05: Great color. Thanks, David.
spk06: The next question comes from Lance Vitonza with Cohen. You may now go ahead.
spk11: Thanks, guys. Thanks for taking the questions. I had a couple questions. The first actually is back on the supply chain, but I'm just trying to understand the accelerating order growth that you saw, which was quite noticeable to 17% year on year. How much of that is, would we say, organic, or is that just reflecting the price increases that you're putting in place? I'm just trying to get a sense for, you know, is volume picking up as well, at least from a demand perspective? I know obviously there are issues with respect to your ability to fulfill. And then the next question is, should we expect the above-average inventory build that we saw in the third quarter? How long does that persist? Is that sort of through the first half of 22 as well? And is the kind of 40 to 45 million of incremental build per quarter, is that a good run rate to model, or is there something else we should be thinking about there? Thanks. Hey, Lance. Thanks for the question. This is Rob. I'll take the first half, and I'll give David the second half on that. As it relates to the growth, and I think we talked last time when we announced the ENI acquisition, we're posting up around 12% orders growth. We did see an acceleration. I would say it's hard to kind of break out, I'd say, right now the price, and certainly there's some price in there, but we're seeing a strong strength in demand. Part of that is people are placing POs, as we are as a company, a little further ahead in the future so that they make sure they get in line. But in general, the market's pretty robust. As you begin to see the comment that someone made earlier around the capex that the hyperscalers and co-owned companies are spending. So certainly there's some price in there for sure, but there's also just a strong underlying growth in the market. David, second half? Yeah, thanks, Rob, and thanks for the question, Lance. So as it relates to inventory, you know, you're absolutely right. So if you look at year-to-date inventory, it's probably up, you know, $130 million from the end of last year and with approximate, you know, $40 million build in the quarter. You know, it's not unusual for us to build inventory during the year and then have that come down in the fourth quarter based on what is usually a very strong sales quarter. I think we're going to see a little bit of that dynamic this year, but probably a little muted. I would anticipate year-end inventory declining somewhat. but very much dependent upon the dynamic out there as it relates to the part shortage. We certainly are not artificially constraining ourselves to hit any internal inventory days or turnover targets. If we can find the parts, we're making the right business decision and we'll buy the parts and we'll park in an inventory to protect delivery for 2022. With that said, we're very mindful of the impact that inventory has on free cash flow, a very important metric for us, and we are implementing, you know, actions one. But we could see an additional build, I'm sorry, a dip in Q4, and we could see an additional build as we go through the first half of next year. Thanks for the caller. Appreciate it. Yeah, thank you.
spk06: Your next question comes from Nicole DeBlasi with Deutsche Bank. You may go ahead.
spk03: Yeah, thanks. Good morning, guys. Good morning, Nicole.
spk12: Nicole, it seems like your name is coming for some variation also.
spk03: Always. I don't even try anymore. well thanks for the question guys I guess maybe starting with um I do have a follow-up on price cost if you don't mind um when you were answering Jeff's question about the floor on pricing the five to ten or price cost the five to ten million for 2022 does that include the pricing actions that you've taken to date I assume it does but I just wanted to check on that and then I guess, like, with the view that 3Q is the worst and that's behind you, is that based on your view that inflation kind of gets worse in the fourth quarter, or is that assuming, you know, normal spot rates, inflation is kind of peaking? Just wanted to understand the philosophy behind that.
spk11: Yeah, thanks, Nicole. This is David. So I'll guess your second question first. So our assumption is that inflation in Q4 is consistent with inflation in Q3, and that's If you want to put a specific number to it, I think everybody at some point is able to triangulate all these numbers on a quarterly basis. But we're assuming $55 million of year-over-year gross inflation in Q4. That was the same number that we saw in Q3. So we don't anticipate that inflation gets any better or worse in Q4 yet. versus Q3, and that's consistent with what we've seen so far in the month of October. As it relates to the wraparound effect for 2022, it's a little bit of a math exercise. So that's just looking at, you know, if you look at that $55 million inflation number we see in Q4, If you wrap that around for the full year, based on what we've seen in 2022, you end up with an additional $60 million headwind for inflation. If you do the same thing for price clued actions that we see in the P&L in Q4 2021, so that's about $30 million. If you wrap that around, you get a $65 million tailwind for pricing.
spk01: And that's the $5 to $10 million that we reference.
spk11: It's kind of a pure math exercise just to give comfort that that's really the floor that we would see on a base case. But of course, that does not contemplate pricing actions that we've taken in Q4 that have not been recognized in the P&L yet. And it also assumes that inflation does not get worse. But we thought that would just be kind of a helpful, you know, gauge for what a floor number would be.
spk03: That is super helpful. Thank you for walking me through that detailed. I really appreciate it. And then, so you talked about the revised outlook for EMEA for the full year. I guess any change to the way you're thinking about North America or Asia Pacific?
spk11: Yeah, this is David. I can start, and Rob and Gary can speak. So, you know, I would say if you look at the dynamics of both pricing and inflation for 2021, America has certainly been impacted more than the other two regions. Oh, I'm sorry, David.
spk03: I meant revenue growth, not price cost. Sorry.
spk11: Oh, okay. Nicole, I'll take that. From a revenue growth perspective, EMEA has had some, I would say, very good tailwinds basically produced by what we call our global accounts team that we've pulled together. So we've seen an aggressive build-out across Europe, partially due to data sovereignty, partially due to – some of the Brexit activities early on and just everyone wanting data centers. So you're seeing a tremendous amount of builds happening in Europe as we speak today. That being said, the outlook, as we look forward and look in our pipelines, as I mentioned, we've got pretty good views. I expect robust growth to be happening really around the globe. I expect America's A lot of people think Americas is done and built out. That is not the case. There's more data centers needed than we currently have today, and I think you'll see an acceleration of growth in 2022 for that. both colo and hyperscale, and as enterprise recovers. And then if you look at Asia, Southeast Asia specifically, COVID has really slowed them down from the ability to build, deliver projects. And I think when that gets unlocked, you'll see a nice set of growth there.
spk01: And then you commented on China earlier.
spk11: I wish I had a better crystal ball as to exactly what was going to happen over there, but we continue to see that as a good market for us.
spk03: Thank you. I'll pass it on.
spk06: The next question comes from Mark Delaney with Goldman Sachs. You may go ahead.
spk07: Yes, thanks for taking the questions. So the first on the ENI acquisition question, You spoke to positive customer feedback that you're receiving. Can you elaborate a bit more on what you're hearing from customers? And I think some of the value proposition is being able to sell a broader set of products. Maybe you can talk specifically to what you're hearing from customers on your ability to provide a broader set of solutions.
spk11: Sure, Mark. Hi, this is Rob. Thanks for the question. In general, the excitement is it actually fills out the portfolio. While we've talked about it in the past that switchgear wasn't necessarily something we had to have, as the systems get more tightly integrated, as we put the controls integrated, data center is becoming more and more a part of it. So they're excited the fact, which you and I didn't have a lot of service organization, we can really kind of complete that entire deal for them. The bus bar category was something that we didn't really participate much in, and E&I is a global leader in providing bus bar. And the excitement, I would say, when we talk to a lot of the global colos and hyperscale, is the fact that we'll help accelerate and bring these products to all places in the world. E&I hasn't really been very present at all.
spk01: They don't have a factory in India or in China or the rest of Asia. Asia.
spk11: So the fact that they can now get global consistency, global products, and the modularity side of it is a big one. E&I has done just an incredibly open in South Carolina, which have been receiving orders for modular.
spk01: So give Europe, Croatia, but in areas in the U.S., we would sub that out maybe to a third party and have them assemble
spk11: our equipment and pull that together. Now we'll have that as in-house capability and that core thing. So in general, it wasn't anything to do with the exception of with the backing of services, inverted sales, inverted global reach.
spk07: That's helpful. And the second question was on supply chain. It may be a two-part question there. First, excuse me, In terms of supply chain compared to when you gave the business update in September, is it incrementally better, incrementally worse, any change over the last month or so? And then the second part is you're expecting supply chain to be tight through at least the first half of 2022. Can you elaborate on what you're hearing from your suppliers, what's most difficult to procure, and what's behind that comment around supply chain being tight through first half next year? Thank you.
spk11: Sure. And, you know, this is an ever-changing environment. So we had been speaking in the past, you know, about fan situations. Our engineering teams work diligently to qualify additional fan manufacturers to bring into our build and bring into our product. So some of the things have eased up and actually are beginning to get better as we bring some new suppliers on. I would say that still neutral on where we talked about chips, working with our chip manufacturers, and that capacity coming online end of the year, coming into Q1, Q2. Again, big spag on what people are saying in the market, but as we talk to our suppliers there, they feel like they'll have the capacity beginning to come on middle to the end of Q2 from that. As we think about breakers, which we all use breakers, and there's a few circuit breaker manufacturers on a global basis, that seems to have gotten worse from a supply perspective versus when we talked before. I'm not sure that it's bottomed out, but I think it probably is getting close to that from a lead time going out. And then some of the things that maybe are getting better but still spotty is the IGBTs, which we've talked about in the past, and some of that was just due to the fact that COVID was affecting some of the factories in Vietnam and other parts of the world, and we'll see them coming back online. So in general, maybe a few parts, and a little more detail, you probably want a few parts getting a little bit worse from a lead time perspective and some things improving and improving. Again, our thoughts are, well, we don't have a perfect crystal ball. If all the things we're being told from the supply base, things should begin to get better for the second half, which we talked about for next year.
spk07: Thank you.
spk06: Your next question is from Andrew Obin of Bank of America. You may go ahead.
spk02: Yes, good morning. Good morning.
spk00: Good morning, Andrew.
spk02: Thank you for answering a lot of questions, but how have your win rates on new projects trended year-to-date, particularly given capacity constraints, and any quantification you can give around the benefit from new product introduction?
spk11: I'll start with the second one first, and then Gary can comment a little bit about some of the win rates. But what I tell you is we're very excited about some of the new products that we've talked about in the past that have launched that have been received quite well. One area that I've been excited about is in our thermal management area. where we continue to be a world leader and a global supplier of that. The dynamics of changing of what people want to use in the data center, while a lot of people are straying away from water, we have a really good system that is waterless. very efficient, that helps them drive towards their carbon neutral platform. That would be one example that we talked about in the past, and we've seen a better than expected uptick of that. So people are liking the innovation, liking what we're bringing out. I would say in the channel side of things as well, the solutions that we've been bringing to the channel, whether it's first in some of the lithium-ion battery products, our Geist kind of award-winning power distribution product line has had several launches that have picked up. So in general, I guess I am – more than thrilled with what we've delivered so far and really excited, as Dave mentioned. Cody, we continue to pour gas on the fire for innovation, and we'll continue to deliver those products both in channel and in the colo hyperscale and enterprise space. Gary?
spk10: Hey, Andrew, it's Gary. So I think in terms of your first question, You know, the two things we do watch clearly are, you know, how is the pipeline trending and then what is our win rate by product line and by region. And for the most part, pretty good visibility into both of those. Pipeline continues to accelerate, particularly if I look at where we sit today versus even a year ago at this time. And then the win rates are also, you know, worst case, flat, maybe even a little bit better in some areas, largely due to the new product introductions that Rob talked about. So those are very much tied hand in hand. So for... You know, where we sit today, I think the order rate is certainly commensurate with pipeline activity increasing, as well as wind rates probably even inching up versus what we would have seen a year ago.
spk02: Oh, great. Thank you. And just maybe to build on this answer, you know, as you talk about, I think people brought it up, you know, the industry perhaps even inflecting into 2022. We're hearing a lot of stuff. You hear hyperscalers starting to come up with proprietary technology. I think a couple of years ago, 3M was highlighting its own proprietary liquid for cooling. I'm not sure what happened there. There's talk about things shifting from edge to the cloud and from cloud to the edge. You know, just big picture, what are the big themes and new exciting stuff on the horizon, and how are you guys positioned if, you know, sort of can take a longer term view? Thank you.
spk11: Great question. And a lot of people read into hyperscalers and what they're doing. And certainly one of the areas that the hyperscalers have spent time and innovation on is around the servers themselves, the servers, the storage, and doing a lot of that development themselves, doing their own chips. Several have announced that. As it relates to infrastructure, we do a lot of collaboration with them. There's certainly hyperscalers. Some want things done exactly the way they want them, and so we're a collaborator, a provider, using RIP. in some cases a mixture of joint IP, but for the most part RIP. So we don't see them going in a big way into our space as it relates to large power, large thermal, but we do see them influencing our verted product development as we go forward from that perspective. As it relates to technology, what you're referring to with 3M is really their two-phase immersion cooling fluid that they talked about, and we see that really originating in Bitcoin operations where there's really high-density, super high-density servers, and immersion cooling is just yet another way to take the heat out in a high-density situation. If you think about the landscape it will continue to evolve and while we're involved with immersion cooling and i think i've talked about this before with the single phase three two phase we're involved in both of those as part of our r d and we're deploying and we have partners there i think you know if you think about where where the industry will continue to change and evolve as one of our sweet spots and that's the thermal and continue to whether it's immersion whether it's cold plates and and and some cooling at the chip level All those things Virta's engaged with and very forward-thinking on things that are going to be two to three years out. So we feel good about that. The other area that I think you'll see a focus on is generators, right? Generators is an area that creates a lot of concern, and they're not – looked upon as favorable for siting and so forth. So maybe alternate ways of doing tighter integration with renewables and even things such as fuel cells, which I wouldn't have thought in my lifetime would become it began to become more mainstay but with with fuel cells and solar and wind and battery storage those are some of the things i think if you look at the future um they've been talked about by by a lot of the hyperscalers and colos and certainly vertive you know with its increased r d budgets are participating in collaboration and making sure we have a we have a place in that game oh thank you for a great answer i appreciate it thank you andrew
spk06: Again, if you would like to ask a question, press Start and the number 1 on your telephone keypad. Your next question comes from Steve Trusa with JP Morgan. You may go ahead.
spk08: Hey, guys. I guess good afternoon at this stage for me. Just looking, maybe this is just parsing the numbers a little bit too much, but when you look at the numbers we were assuming for December contribution from the ENI deal, And we multiplied those by 12. We got pretty close to your guidance for that, for 22. When we look at the numbers you're giving now on kind of November and December, taking those two months and then annualizing them, I get to kind of numbers that are – you know, significantly below what you would guide it to. Any seasonality around these numbers that, you know, one month isn't equal kind of to the other as we get toward the end of the year just seems like the contribution you're now forecasting is just a little bit light of what we were expecting around year end. Or maybe they're having supply chain issues as well.
spk10: Hey, Steve, it's Gary. So I think there's probably a little bit of all of that, what you just said. First and foremost is probably what Rob's comments earlier alluded to in terms of site readiness. So whether that is literally getting concrete poured for some of these new sites, and or having trade labor on the other hand to be able to receive it and invoice it in time so there's some things that we're probably going to ship at the end of december that most likely are going to push to january so there's certainly a site readiness issue would be one of them there's a little bit of supply chain and they're no different than what we're speaking about too but rob mentioned electronic parts a few times so they're not immune to that there's a little bit of that and then maybe third is there's a little bit of seasonality but i think most of it is really just chalked up to primarily site readiness with a little bit of the supply chain constraints
spk08: Okay, so we look out like the 570, 140 for next year. Is that still intact? Is that a little more back and loaded? Like what's the update there?
spk11: Yeah, this is David. I would say nothing that we've seen with E&I up to this point has changed our view for 2022 and our expectations for financials. We'll certainly give an update and include that in our guidance when we announce for Q, but I would say nothing we have seen has changed our expectations for next year.
spk08: Okay, and then just one last one. Pretty strong backlog, obviously, on a relative basis. I would have expected, though, with orders up 17%, it would have been our calc is kind of getting us to north of $2.5 billion. Obviously, there's some puts and takes in how you calculate backlog, but is there anything there? Did some stuff move out? Did other stuff move in? Or is the calc just not as easy as, you know, backlog minus sales plus orders.
spk11: Yeah, this is David, Steve. We can work with you on that. You know, there's sometimes an element of rounding in there as well. So our backlog was up close to 200 million in the quarter. The book, the bill was clearly over, you know, in that 115, 120% range. But we have made, you know, no significant adjustments as it relates to the backlog, meaning, you know, you know, booked orders coming out. There is sometimes a FX component to it that creates some noise, but I would say there's nothing significantly that has changed with how we calculate backlog.
spk08: Okay, great. Thanks for all the color. Appreciate it. Thanks, Dave. Perfect.
spk06: There are no further questions at this time. This concludes our question and answer session. I'd like to turn the conference back over to Rob Johnson for any closing remarks.
spk11: Well, again, thank you for all being here today, and thank you for your continued support. As you can tell, we're pretty excited about what we're going into for 2022. We'll get through these supply issues, and we'll continue to invest in our R&D and continue to bring new products to market that has the innovation that our customers are looking for. So thanks again. Have a great day.
spk06: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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