Vertiv Holdings Co (VRT) Q1 2021 Earnings Report, Transcript and Summary

Good morning. My name is Grant, and I will be your conference operator today. At this time, I would like to welcome everyone to Vertiv's First Quarter 2021 Earnings Conference Call. [Operator Instructions] 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, Lynne Maxeiner, Vice President of Investor Relations.

Great. Thanks, Grant, and good morning, and welcome to Vertiv's First Quarter 2021 Earnings Conference Call. Joining me today are Vertiv's Executive Chairman, David Cote; Chief Executive Officer, Rob Johnson; Chief Financial Officer, David Fallon; and Chief Strategy and Development Officer, Gary Niederpruem. 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 Vertiv. These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We refer you to the cautionary language included in this earnings release, and you can learn more about these risks in our registration statement, our 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 presentation and press release, also the investor slide deck found on our website at investor [Audio Gap] .com. With that, I'll turn the call over to Executive Chairman, David Cote.

Thanks, Lynne. This is now the fifth quarter we've reported as a public company, and I think you can see what I've seen and talked about this entire time. This really is a great company in a really good industry with multiple ways to continue improving the top and bottom line. Rob and his team, as you can see, are making great progress with new products, global growth and the process initiatives like the Vertiv operating system, Vertiv product development, customer view and functional transformation. And these process initiatives show that there are lots of barriers to improve upon, and Rob and the team are focused on those. But I think you'll also agree with me that the first quarter results sure are something to be proud of and provide us a great start to the year. So with that, I'll turn it over to Rob.

Thanks, Dave. Thank you for your guidance that you provide to me and the executive team and the support for Vertiv that you always have given. We really appreciate it. To all of you on today's call, thank you for being here, and I'm eager to share more about our performance for the first quarter, our outlook for the market and give you a glimpse of a few new products Dave just talked about that our talented and innovative teams at Vertiv have developed. Turning to Slide 3. There are 5 key messages I want to convey today, and we'll share them at a high level, and David will elaborate more on the financial details in just a few minutes. First, I'm pleased to report sales were up more than 22%, and orders were up 21% versus Q1 of 2020. Growth happened in all regions across all major verticals, and we ended the quarter with a record high backlog of $2.1 billion. Second, from a profitability standpoint, our adjusted operating profit was $112 million, which is up $92 million or 450% from last year's first quarter. This resulted in adjusted operating margin expansion of over 790 basis points, driven by higher sales and lower fixed cost on a percentage basis. Third, our free cash flow at the end of Q1 was $43 million, an improvement of $246 million, made possible by higher earnings and lower interest expense. Fourth, the market is facing supply chain and commodity cost challenges, and Vertiv is not exempt. We are aggressively working to secure supply needed so that we can provide on-time delivery to our customers, first and foremost, while developing and executing strategies to share the cost with our customers where possible. Because supply chain constraints, coupled with inflation, we will see some incremental unexpected costs over the short term. And fifth, and the final key message, we are raising our 2021 sales guidance by $125 million, such that the new sales guidance is between $4.8 billion and $4.9 billion. And raising our adjusted operating profit guidance by $20 million. So our operating guidance is now $585 million to $605 million. This demonstrates our confidence in the end markets and the confidence in our teams all across Vertiv to perform in accordance with our strategy and to meet the growing needs of our customers. Let me elaborate on these 5 key points using the next few slides. Turning to Slide 4. We've been using this slide quarter-to-quarter to talk about our end markets and illustrate activity in each of our regions around the world. A red button on the slide indicates sluggish performance. A green bucket -- green button indicates strong performance. And a yellow button indicates something in between. Cloud and hyperscale and colocation markets have been very strong and remain strong across all regions. The demand for digital applications, online education, telemedicine, video and gaming is booming, benefiting our cloud and colocation customers and driving a strong and growing need for Vertiv products and services around the world. In our enterprise, small and medium business market, we're seeing signs of improvement as well. Our 2 reds have now turned yellow, but it's still not clear when the entire enterprise segment will open up. We are, however, encouraged to see things moving in the right direction. The communication networks market stayed constant in Americas and EMEA. It improved in APAC over the quarter, and we were able to see a shift in the market from yellow to green. Americas and APAC are performing strongly in this segment. Americas activity is driven by several large U.S. telecom carriers and the continued rollout of 5G. In the commercial and industrial market this quarter, EMEA has shifted from red to yellow. And because of that, we are now showing solid yellows across all regions, indicating some positive movement in the commercial and industrial space. All the end markets we serve are good -- are in very good shape now, as illustrated by the rays of yellows and green across the slide for Q1. Digital applications continue to increase their importance in everyday life. There's no -- they're no longer nice to have but a necessity for individuals and for businesses. The increasing need means there's an increasing demand for the processing, storage and transmission of data, which creates significant opportunity for Vertiv, and we are perfectly poised to go after that opportunity. Moving to Slide 5. I'd like to make a few comments regarding supply and demand. As I mentioned earlier, the overall market demand is strong, as evidenced by our order rates and backlog, which has resulted in us raising guidance. Each of our regions saw revenue growth in the first quarter, led by continued strength in cloud and colocation markets. Our cloud and colocation customers continue to build data centers in an aggressive but balanced fashion, and we will continue to partner with them to meet the strong and growing demand. We continue to stay vigilant around COVID, keeping our employees, our customers and our partners safe wherever they are in the world. That is our main priority. We have made adaptations where necessary and have found solutions to business challenges brought on by COVID. We remain confident in our ability to serve our customers and meet their needs. Yet, similar to other companies, we are facing some supply chain issues due to market conditions. There are a couple of things that are going on here. First, we find ourselves dealing with some parts shortages and materials. For the most part, we've identified solutions for those. Second, like many other companies, we are seeing cost increases on both material and the logistics side. This is being tracked and managed and closely monitored, and we are taking actions to offset the increased costs. But nonetheless, this is a short-term headwind. We've been planning to implement some footprint optimization programs. We have pivoted and decided to delay some of those programs to take advantage of the strong demand environment. The footprint optimization plan will be executed, but it will happen a little bit later than originally expected. Moving to Slide 6. I've talked to you in the past about our Vertiv product development process, VPD, and you all know about the allocations and resources we have made to research and development. So I wanted to show you a few of the new products. I can't tell you how thrilled I am with the progress that's being made in our engineering teams and all those that are responsible for executing our strategy to innovate, design and build products for the future. Here are some early results on this slide. The first product, shown in the upper left, will formally be launched tomorrow, and it's another way that we're helping our customers to become more efficient and provide lower carbon offerings. It is a grid interactive UPS, which will allow data center operators to use the UPS to power their data center and during low power times, to inject power back into the grid to drive the efficient use of data center equipment. On the upper right is the newest addition to our thermal offerings. We continue to innovate in the thermal space to drive more efficiencies and to provide best solutions for our customers. This product provides liquid cooling for high-density servers and racks, providing customers with an efficient way to cool their high-density applications. Finally, on the bottom of the chart, you will see 2 of our new edge offerings. The product on the lower left is a small UPS that's very efficient, very compact and utilizes the latest in lithium battery technology for longer time back -- for longer backup time. The product on the lower right is our newest single rack data center, which includes integrated UPS, power distribution, thermal management and our secure switch. This is a preconfigured solution and is a great example of the type of product we are bringing to the market for distributed IT and new edge applications. I really could talk hours about the research and development at Vertiv, but wanted to highlight a few of the new products so you can understand how we're focusing our R&D efforts and allowing us to bring these innovative solutions and offerings to our customers into the market. With that, I'll turn it over to David for a closer look at the Q1 numbers and come back at the end with some final comments. David?

Great. Thanks, Rob. First, turning to Page 7. This slide summarizes our first quarter results versus last year. Net sales were up $201 million or 22.4%, 19.5% when adjusted for a $26 million foreign exchange tailwind. We continued our strong momentum with orders, which were up 21% in the first quarter after increasing 10% in full year 2020. Adjusted operating profit increased $92 million or over 450%, primarily driven by the profit flow-through from the higher sales and the benefit from SPAC transaction costs in last year's first quarter, all translates into a 790 basis point improvement in adjusted operating margin. Adjusted EPS at $0.21 is $0.86 higher than last year, driven by the improved operations and a $0.54 benefit from the $174 million loss on extinguishment of debt and $21 million of SPAC transaction costs in last year's first quarter. Our sales and profitability performance converted into strong free cash flow of $43 million, $246 million higher than last year's first quarter, and we will review some of the drivers of this improved free cash flow in a couple of slides. So turning to Page 8. This slide summarizes our first quarter segment results. Net sales in the Americas were up $35 million or 7.5%, driven by growth -- strong growth with hyperscale customers in our critical infrastructure and solutions product segment. Net sales in APAC increased $133 million or 60%, in part due to an approximate $50 million COVID impact on sales in last year's first quarter, but we otherwise experienced strong growth across most APAC subregions and market verticals, including data centers, telecom and commercial and industrial. Net sales in EMEA were up $33 million or 16%, predominantly in the critical infrastructure and solutions product segment, driven by several larger colocation projects. From a profitability perspective, adjusted operating margin improved across all 3 regions, primarily due to the leverage benefit of relatively flat or lower fixed costs on significantly higher net sales in each region, providing a practical example of the potential margin benefit of maintaining fixed cost constant while growing the top line. Next, turning to Slide 9. This chart bridges first quarter free cash flow from last year. The $246 million increase is primarily a result of higher adjusted operating profit, lower cash interest payments and improved trade working capital in addition to a $21 million year-over-year benefit from SPAC cash transaction costs last year. The $43 million of free cash flow in the quarter was higher than our internal expectations, primarily driven by the timing of a cash disbursement of approximately $25 million at the end of March due to a system implementation. So we anticipated that cash outflow to occur at the end of March, actually occurred at the beginning of April. Although it does not impact free cash flow, we received $107 million at the beginning of the first quarter, pursuant to the final public warrant redemptions. And this certainly facilitated a record-high liquidity of $1.1 billion and a record-low net debt leverage ratio of 2.3x at the end of the first quarter. Next, turning to Slide 10. We wanted to address the change related to the accounting for our warrants. Last week, we issued a press release and filed an 8-K providing more detail on this matter. But pursuant to new guidance released by the SEC on April 12, we changed the historical and prospective accounting for both our public and private warrants to record a liability for the fair value of these warrants. And with any subsequent change in fair value, adjusting the liability and recording a noncash nonoperating gain or loss in the P&L. When our stock price increases, the liability increases and we record a noncash loss. When our stock price declines, the liability declines, and we record a noncash gain. As a result of this change, we will file an amended 2020 10-K in the coming days, reflecting these changes, including recognizing additional noncash nonoperating expense of approximately $144 million in fiscal year 2020 as our stock price increased significantly during the year. We also recognized a $14 million noncash loss in the first quarter. This warrant gain or loss is recorded below operating profit, and it will not impact any of our non-GAAP operating metrics, including adjusted operating profit, adjusted EPS and free cash flow. So next, turning to Slide 11, looking forward. This page summarizes our second quarter financial guidance. We expect first quarter top line momentum to continue in the second quarter, with net sales up 20% at the midpoint, with strong growth across all 3 regions. And our second quarter sales is also expected to be up 10% sequentially from the first quarter. We guide towards adjusted operating profit of $125 million at the midpoint, up 21% from last year despite a $30 million headwind from one-off COVID cost actions in last year's second quarter and a $25 million increase in year-over-year growth in R&D investments. Adjusted operating margin is expected to be relatively flat, with contribution margin percentage slightly lower than last year due to commodity and logistics inflation. And despite higher year-over-year dollar fixed costs due to last year's COVID actions and incremental investment spending this year, fixed cost as a percentage of sales should be slightly lower. Finally, adjusted EPS is expected to increase approximately $0.07 or 44% at the midpoint, driven by the higher adjusted operating profit and lower interest expense. Next, turning to Slide 12. We summarize our revised full year 2021 financial guidance, including higher net sales expectations to $4.9 billion, up 12% from 2020 and $125 million higher than our prior guidance, $60 million of that from the first quarter and -- or $60 million in the first quarter and $65 million over the remainder of the year based on our strong first quarter order performance and backlog. We are increasing our adjusted operating profit guidance to $595 million, up $20 million from prior guidance, and we will provide some detail of this increase on the next slide, including quantifying the expected net financial impact of the commodity and freight headwinds, as Rob discussed. Full year adjusted EPS is expected to be $1.11, $0.07 higher than our prior full year guidance, driven by higher projected -- adjusted operating profit, about $0.05 there, and lower interest expense from our first quarter term loan refinancing, about $0.02. Finally, we are increasing our full year projected free cash flow to $300 million, up $15 million from our prior guidance of $285 million. Turning to Slide 13. This chart bridges our full year adjusted operating profit from prior to current guidance, a net increase of $20 million, with a favorable $35 million coming from an incremental $125 million of net sales, however, converting at a rate lower than our average contribution margin due to product mix and higher marginal manufacturing costs, including expedited freight in some cases as we manage our capacity to meet the higher customer demand. Partially offsetting these volume benefits is a $15 million net headwind, including $25 million in commodity and freight inflation, approximately $15 million from commodities and $10 million from freight, both disproportionately impacting the Americas. This cost inflation is partially offset by an assumed $10 million of incremental pricing. And we believe there is further opportunity for additional incremental pricing as we progress through the year. With that said, I turn it back over to Rob.

Well, thanks, David. Overall, I'm very proud of the Vertiv team and what we've accomplished since becoming public. We've been executing our strategy, as Dave Cote has alluded, whether it's the VOS or the product development, all the levers we've talked about, and we feel really good about the next 2, 3 years as we continue to execute that strategy. I believe our results for this quarter have demonstrated the hard work and the effort of the 20,000 employees we have around the world. As I look into the balance of 2021, we continue to anticipate above market top line growth and increase in profitability and a strengthening balance sheet, all while continuing to invest in the strategic areas, as we've talked about, R&D and sales and marketing. To all the employees on the call today, thank you again for your dedication and your tireless effort to take care of our customers. To all the investors, thank you for being on the call today and for your support over the past year. I'll now turn it over to the operator, who will open up the line for questions.

[Operator Instructions] Our first question today will come from Andy Kaplowitz with Citigroup.

Rob, last quarter, you had mentioned that you thought order growth could sustain in the high single-digit range, but obviously, in Q1, you reported low 20% order growth. So maybe give us a little more color into what was the incremental upside versus your expectations. Was it more continued hyperscale and colo outperformance? Or was it an enterprise beginning to come back? And has your order outlook improved for the next few quarters where you can sustain more of this double-digit type order growth?

Yes. Great question. And you're absolutely dead on with the colo and hyperscale. Typically, those don't fall into our flow rate business. So those orders come when they come. And we look them in the pipeline, but when they want to release them. And typically, we'll get those orders anywhere from 3, 6, 9 months in advance of deploying those. And what we've seen certainly is a tightening market and longer potential lead times. And I think as we look at the global build-out continue, it's just stronger than we necessarily expected and probably saw people making sure they get in line to get their supply going forward. So -- but I'm encouraged going forward, and you've seen -- I know a couple of others have released today, Google and Microsoft. And we're seeing strong and continue to see strong growth there on a global basis. So I'm positive to that. And as I mentioned earlier in the call or in my script I was going through, we are seeing signs of really good life in the enterprise. We'll see when that fully turns back on, and that could be additive as we watch that come back to life.

And then Dave, can you give us a little more color into the Q2 guide in the sense that you actually forecast Q2 sales to be up $100 million versus Q1, but adjusted operating margin at the midpoint looks relatively similar. So I think you said fixed costs would be lower as a percentage of sales versus a year ago in Q2. But what does that metric look like versus Q1? And what are the headwinds sequentially? Maybe FX not as good? Do you dial in more negative [indiscernible] cost and higher investment spend? Maybe you could go over the pieces for us a little bit, that would be helpful.

Yes, absolutely. Thanks for the question, Andy. So if you look at the components sequentially, so Q1 adjusted operating profit was $112 million. We're guiding $125 million, so $13 million increase. We do anticipate to see a straight pass-through from a profit perspective on the higher sales. I think sales are up $110 million or so sequentially. We do expect to see a 40% drop there -- on those additional sales. So we don't see any negative impact from a contribution margin percentage perspective in Q2 versus Q1. Really, a little bit of a drag quarter-over-quarter Q2 from Q1 is on the fixed cost side. So we anticipate probably about $20 million of higher fixed costs in Q2 versus Q1. And a lot of that is driven by the timing of R&D and growth investments. And in fact, we had planned $10 million of R&D and growth investments in the first quarter, and a good portion of that actually slipped into Q2 because of the timing of hiring and the launching of a few projects. But the other element that has an impact sequentially is the annoying FX gain and loss dynamic. So we had a $7 million FX transaction gain in the first quarter. Based on the weakening of the euro at the end of the quarter, the euro has since recovered from [ 1 17 ] up to close to [ 1 21 ]. So we probably have about a $10 million headwind from that FX transaction gain/loss dynamic in Q2 versus Q1. So all that flushes out relatively flat adjusted operating margin right around 10.2%, 10.3%. But as a result of the timing of some of the fixed costs, the actual dollar increase in adjusted operating profit is probably lighter than what some expectations are.

Our next question will come from Mark Delaney with Goldman Sachs.

The company mentioned that product mix and higher marginal manufacturing costs are impacting margins this year. I was hoping you could be a little bit more specific on what those issues are. And are you expecting those to be more temporal issues? Or is that something that could continue into next year?

Yes. Thanks, Mark. This is David. I'll start, and Rob and Gary can add on. So yes, we called out an additional $15 million, and this is current guidance versus prior guidance as it relates to these additional mix and incremental manufacturing costs. From a product perspective, if you look at our product segments, our critical infrastructure and solutions product segment is a relatively lower margin than the other 2. And some of that -- or a good portion of the $125 million incremental sales are in that product segment. And so if you look at incremental, $15 million probably, half of that is related to that product mix. The other half is related to satisfying the demands of our customers. So I mentioned in my comments, we have -- in order to meet customer demands, in certain cases, we've had to enlist expedite freight. In addition, we have ramped up our capacity in some of our facilities, including adding shifts and temporary labor. And as a result, some of these marginal incremental sales are coming in at a little bit lower contribution margin than we would otherwise anticipate. We would expect -- these additional manufacturing costs certainly will be temporary. We do have a long-term capacity planning project that is ongoing, which will support the higher growth, and we believe we'll be able to transition away from a lot of these higher incremental costs in the second half of the year. So a lot of this incremental cost that we're seeing, we do anticipate in the second quarter.

Okay. That's helpful. And a follow-up question, I was hoping to better understand how the company is thinking about deploying free cash flow going forward. I mean, there's been really good progress reducing debt, lowering your interest expense. And the opportunity has been discussed at some point in the future. Perhaps the company could return to doing some tuck-in M&A or perhaps even a larger-scale M&A, which there's been some success with historically. I know there's a few acquisitions the company has been pretty happy with. And I think investors are interested in what potential there may be to do that type of acquisitions going forward. So any updated thoughts you can share about how you're thinking about deploying free cash flow going forward. And is M&A something that you're considering?

Yes. Mark, this is Rob. I appreciate the question, and I'll start and then throw it over to David. But as we've talked about before in past calls, we do have an active funnel of potential companies that we think would make sense to be part of our portfolio. As Dave Cote has always said, opportunities and -- present themselves, not necessarily in timing, not when you want them to. And so we continue to work through that list and keep those type relationships and have eyes on things. As we've talked about before, it's always been about deleveraging first, and I think we've done a pretty good job doing that and have ourselves in a pretty good position to do some things if the opportunity positions itself. And we are actively -- always actively looking, but nothing that's imminent that we can talk about today. David?

Yes. I totally agree, Rob. And I would say this is a very pleasant position to be in as a CFO. So I think pre-SPAC transaction last year, we were over 6x levered. So to get that down closer to 2 really demonstrates the free cash flow DNA of this business, and it absolutely provides us the flexibility to be strategic with our balance sheet. We certainly don't have a strategy to do a deal because we think we need to do a deal, but we will be patient. And we certainly have the flexibility to do something relatively quickly if the right opportunity arises.

Our next question will come from Amit Daryanani with Evercore ISI.

I have 2 as well. First off, when I think about this 10% organic growth, we're talking about 2021, can you perhaps provide some dimension on how do you think about the various segments, purely hyperscale, enterprise, communications, doing? And maybe what I'm really trying to get to is I want to understand what happens to your growth vectors if enterprise grows from yellow to green over the next [indiscernible].

Well, listen, Amit, thanks for the question. And Gary and I will work this one together with you. But I would say, in general, the way we've looked at things is conservatively seeing enterprise come back online. Although I've been talking for a couple of quarters, the thing that gives me the comfort that it will is the quoting activity and the level of quotes. So I would say that as we see the enterprise turn from yellow to green, certainly, there's potentially some upside from that perspective. But I would say, in general, we continue to see the strength in the colo and the hyperscale. And as I mentioned in my comments, we think they're being very diligent about their build-outs as they go forward based on capacity needs that we see kind of around the globe. I don't know. Gary, any thoughts?

I think that's right, Rob. I think, Amit, that we were pleased to be able to upgrade that enterprise segment from red to yellow. We know we had a lot of conversation around that in February. So we've definitely seen enough strength throughout pointing the quoting in the pipeline where we felt comfortable upgrading that segment to go from yellow to green. I think we need a little bit more. And maybe towards the end of the year, we'll get there. It's a little bit unclear, but certainly feel squarely comfortable that, that enterprise is coming back in the segment that we would traditionally talk about.

Got it. And then if I can just follow up. The fiscal '21 guide from a profit dollar basis, I think there's a $65 million of investments in growth [indiscernible] has called out. I'm curious. Is this -- do you think [Technical Difficulty]

Operator, we probably want to move to the next and see if Amit gets back in the queue. I think we lost him.

Amit, are you there?

I'm here. Can you hear me?

Yes, we can hear you now. Welcome back.

Perfect. We'll blame it on the mute function. I was going to ask you on the fiscal '21 operating profit guidance, I mean you talked about the $65 million of investments in growth in R&D. I would like to understand, how do you think about payback from these investments? And do we think about this $65 million kind of a 1-year thing? Or could it sustain for a couple of years?

Yes, great question. First, I'll answer the last part of that and then get to the first. We have talked about in our strategy that we want to get to about 6% overall of -- for R&D. And so we've seen some ratchets up over the last couple of this year and last year and even next year to get to that 6%. And we plan on kind of holding it at that just based on the need, right? Really, what we're doing is taking a look at the funnel of projects, the collaboration that's needed by our customers, and doing what we need to do to really drive innovative solutions that will help us outpace the market growth and take share as we go forward. Certainly, there's not a lack of activities that we believe we can do to create more value for our customers and ultimately more value for the share owners. But as you think about it going forward, you think about it getting to about a 6% level, and we think that will be sufficient with the growth rate that we're going to have, which would give us additional R&D dollars every year, just holding it at 6%. Now David, any other thoughts?

No, just from a numbers perspective, so that $65 million, it's -- at least for 2021, $35 million of that is R&D and with the remainder $30 million related to sales and marketing. And to Rob's point on R&D, last year, we spent $230 million on R&D, add another $35 million this year, that's $265 million. And based on the most recent top line guidance, that's 4.5% to 5%. So to get to 6%, there's certainly going to be some additional step changes over the next couple of years. And of course, the dollar amount also increases, all other things being equal, just with the top line increasing. And the one thing I can tell you is that this is not a capital rationing exercise. There are plenty of projects out there. So there is an efficiency and productivity perspective. You can only do so many. So there, the ability to increase this dollar spend, we're not chasing the last dollar. So there is plenty of opportunity for us to continue to invest. And all of these projects have really, really good returns, and that probably was the first question. And that payback period is anywhere from 12 to 24 months, depending on the specific project.

Our next question will come from Nicole DeBlase with Deutsche Bank.

So can we start with the outlook for revenue [indiscernible]. When you think about where organic growth is getting better expectations, particularly with respect to like [ 4Q ], can you talk about that segment? And any color you have in the second quarter?

Nicole, you were cutting in and out a little bit. Is it possible to restate the question? Just -- we were getting every third word here.

Yes, sorry about that. Is this any better?

A little bit, yes.

Okay. I was just looking for color on full year organic revised and Q2 organic segments.

Yes. This is David, and I can ask Rob and Gary to add some color. We don't provide guidance as it relates to a product segment perspective, and we can give some color on that. But certainly, from a regional perspective, if you look at Q2 this year versus last year and the 17% expected organic growth, give or take, that's going to be pretty strong across all 3 regions. So probably low single digits in the Americas, and in both APAC and EMEA, somewhat over a 20% growth. So this is not a situation -- the reason we mentioned that is this is not a situation where we anticipate another 40% or 50% growth in one region and all the other 2 regions are single digits. So we're expecting strong growth in Q2 across all 3 regional segments. Now when you look at first half versus second half, and all the numbers are out there, so everybody can do the math. It certainly does imply lower organic growth in the second half of the year. So organic growth in the first half of between 15% and 20%, that would imply low single digits in the second half of the year. What we can tell you is we did not expect that low single-digit to be uniform in Q3 and Q4. We do anticipate Q3 from a percentage growth perspective to be higher than the year-over-year growth that we see in Q4. So Q4, last year, if you recall, presents a very, very challenging comp, right? We had sales over $1.3 billion, including exceptional sales in EMEA based on the timing of some larger projects and also APAC. So there could be some conservatism built into our guidance in the fourth quarter. We just don't have the visibility at this point to really lean forward too much on Q4. And we do anticipate that to have more information related to orders and pipeline when we update our guidance in Q2.

Okay. Got it. That's really helpful. And just for my follow-up, I know you guys are trying to offset some of these extra costs of pricing. Can you just talk about the general pricing environment and maybe the competitive landscape?

That's a great question, Nicole. We have, as we've talked about before, been able to get price the last year, couple of years. I think we're getting pretty good at doing that. When we've had times before where freight costs have gone up like they have been, we've been able to institute surcharges. Sometimes that's lagging, and I mentioned a few -- in some of my comments, some of the lagging to pick that up. And then based on contracts and orders, working with our customers, everyone understands that commodity prices are going up, steel is doubled, that type of thing. Our customers are pretty good about working with us and going through that. Certainly, we're able to go forward price things at that higher cost rate. And we're able to get that. So we feel good. We have $10 million, I think Dave showed in his bridge, of incremental additional pricing this year. While that's something we're striving for, we think we could probably do better than that. But based on what we see, based on where we're at, that's kind of what we built into our plan. But no, we've got a pretty good process now in our ability to drive prices through with our customers on a global scale.

Next question will come from Scott Davis with Melius Research.

Appreciate the commentary, as usual. But I'm going to go back to a few questions ago on the enterprise side, small, medium segment. What's your sense of the age of the installed base in that category, meaning when you go from yellow to green, is it going to be kind of green on steroids because not only is everybody back in the building, but they're back in the building with old equipment that's going to age out pretty quickly? Is that a fair way to think about it?

Well, I guess, yes, the way to kind of think about it, Scott, would be that during COVID period, people haven't been spending, and that equipment will. I can't give you an exact what the installed base would actually look like and what that ramp would be. What we are seeing early signs of is people upgrading their closets as they drive more to cloud and colo, upgrading their network closets, refurbishing old gear, certainly where there's old batteries and that type of thing. So certainly, when it goes to bright green, we would expect to see probably stronger than traditional growth in that enterprise because there's been -- and the reason I say that is we see the quoting activity. We see what's happening at the engineering side of things. And we do believe when that frees up, I don't know if it all happens overnight or it's a slow, kind of like we saw in this last quarter, slowly easing back into it. I mean I think a lot of it's going to be determined around what happens with the back to work with COVID vaccine, which we can't predict. But I think those things can be correlated and tied to people saying, I feel good about spending again. When people are back in the office, they're used to this level of service at home now. With the remote working, they're going to want to make sure that their gear in the office is where it needs to be.

Okay. That's helpful. And then as a -- just a point of clarification, the -- is there anything in your covenants or kind of structure -- this is my first SPAC coverage, to be fair -- that would preclude buybacks of any magnitude?

This is Dave. Scott, there is not. There is not.

Okay. Okay. So if your leverage ratio were to get, let's say, under 2 turns or something and you wanted to do a buyback debt, that's in the cards, correct?

That is one of the options on the table for us, absolutely.

Our next question comes from Jeff Sprague with Vertical Research.

First question may be actually related to Scott's. Services in Americas, at what point do we start to see some traction there? Does it end up being actually tied to kind of new equipment on the enterprise side? I wouldn't think it's directly related, but they kind of seem to be tracking similar?

Yes. Jeff, it's Gary. So I would say, I think there's a couple of things. One is, first quarter in Americas for service was down a little bit primarily because of 2 main issues. One is, if you remember, we had those horrible storms that rolled through most of the U.S., a lot of it in the Southeast and Texas area. So that prevented some site access and pushed some jobs out a little bit. The other portion of it was we have a decently large commercial and industrial service business in the U.S., and that was lagging just because a lot of that is vectored towards utilities, oil and gas, which obviously were depressed from an order standpoint last year. So that business is coming back online. Now we see really pretty strong order rates there, number one. Two, clearly, the weather issue is temporal and that is behind us. So we would expect to see acceleration in that service business, particularly in the Americas as the year goes on.

Great. And on the new 3 phase product, one of your competitors has got something similar that they're talking about. And it's part of what they're talking about developing with that is actually a bit of a SaaS model, too, where they can share with the utility on some of the savings or selling back to the grid. Is that sort of thing available with your product? Are you exploring new business models like that? Maybe you could just elaborate a little bit more on that particular product and anything else interesting in the pipeline.

Great, Jeff, this is Rob. Yes, absolutely. So when we get -- where we are in the belief, the good interaction, we've actually had pilots going for months and even over a year over in Europe, where we'll do that kind of sharing model, revenue-sharing model with the utility where you'll go on battery and inject power back on the grid and/or just free up power for the grid. So there's a couple of different revenue-sharing models there. So as we get more sophisticated and people realize that, hey, it's still reliable infrastructure, even though you're on battery and people get more comfortable with that, we think that, that grid -- and in order to -- the grid interaction is going to play a big part of it. In order for people to drive more carbon friendly, they're going to have to be doing those types of things as well. So we see that and interacting with the grid, whether it's behind-the-meter storage or in front of the meter. And I talked about this before as an area, an adjacency and a growth area as we go forward. So as it relates to -- we'll continue to focus, as we've talked about in the past, thermal management requires -- draws most of the utility expense within a data center, and we continue to drive more efficient, effective solutions, utilizing software controls, AI around that. So we expect to see things like that in the future from us that will just drive that and helping that carbon get to that carbon neutral position.

Our next question will come from Lance Vitanza with Cowen.

I have 2. The first is, last fall, you announced that you would be collaborating, working with Honeywell to improve sustainability for data center operations. And I'm wondering if you could talk a little bit about how that effort has rolled out. Have you seen results yet? Or are we still in the planning or preliminary stages? Are you in the market with joint offerings? How, if at all, does this partnership or this collaboration differentiate you?

Lance, yes, we're really happy with the progress we're making with Honeywell on the collaboration. And that collaboration, we talked about a few different things. I think the first thing we talked about was kind of a software and controls thing to drive more efficiency, where we're piloting that. So we're more than just the planning phase. We've got some pilots. I think a bigger part of the collaboration is us working together globally and bringing Honeywell into areas that they necessarily haven't been into with their software offering, which is a very, very robust offering, along with our equipment and to drive more efficiency as we go through the data center. So we are -- the teams are working together globally and expect -- this isn't something that happens overnight, but expect over time, you'll see more and more of kind of the Honeywell-Vertiv solution showing up in data centers driving -- and really driving efficiency and then joint collaborating on customers they may have, but we aren't currently doing business with and vice versa.

And then just maybe one last one for me. On Slide 13, where you lay out the bridge and focusing on the cost pressures and sourcing and so forth, you show the $10 million kind of recovery from passing price-throughs and this $25 million hit from commodity and logistics headwinds. And I guess my question is, how are those 2 numbers related? In other words, if it turns out that the commodity and logistics turns out to be maybe a $50 million headwind, should we assume that you can pass on perhaps $20 million of the costs? Are they variable in that way? Or no, is it sort of like a hard stop? You think it's going to be tough to pass on more than $10 million so we just need to hope that the impact from the logistics isn't much greater than that? Could you comment on that?

Yes, Lance, this is David. I'll start, and Gary and Rob can jump in. I would definitely say the 2 are correlated, right? The higher the commodity logistics headwind and inflation is, the more data we have and to reasonably take price up consistently with competitors, right? So there's definitely a high correlation. The one thing that we're seeing here is that there's generally a lag. So we will see the negative impact from commodity and logistics sooner in our costs, then we do have the ability to pass that through for higher pricing. Now one thing that we did see, which turns this into somewhat of a positive, the last time we saw significant commodity and logistics headwinds, what we found is that the pricing is actually a little bit sticky upwards. So we actually look at this strategically as a way to get additional price. And then if the commodity and logistics headwinds abate at some point this year or even early next year, generally, the pricing that we see remains where it's at. There's always some give and take. But on the way up, that pricing opportunity is certainly going to be correlated with the headwinds we're seeing. And the other thing that I probably want to point out on this slide and remind folks is that this is versus prior guidance. So this is the overlay for additional commodity and logistics headwinds versus our beginning of the year assumptions. If you looked at this for a full year, we had about $20 million of headwinds for commodity and freight inflation in that beginning of the year guidance. So if you add the $20 million and the $25 million, you get about $45 million. We also had assumed about $15 million of pricing in that prior guidance as well. So full year pricing expectations are now right around $25 million. And if there is additional inflation, we do believe there's opportunity to take those pricing assumptions up as well.

Next question will come from Steve Tusa with JPMorgan.

Just rounding out the rest of those bridge items, I think you had like positive $45 million for productivity for kind of a -- that would be kind of a net $40 million contribution margin, I think. Now it looks like it's $10 million for contribution margin, but first half is negative 20%. So I guess the second half kind of has to flip. I mean are you guys assuming that things -- I mean like what -- can you maybe round out the other portions of the annual kind of year-over-year bridge for us?

Yes. This is David, Steve. And I think everybody's had some time now to kind of put the Sudoku puzzle together and I'd say you did it correctly. So yes. The implication for margin is that there'd be about $35 million favorable year-over-year variance in the second half, and that offsets about $20 million unfavorable variance in the first half. So the reason you see favorability in the second half is because of the timing of some of these initiatives. We do assume that pricing will ramp up as we go through the year. So the $25 million in total, there's probably a relatively small number in the first quarter, and that will ramp up as we go through the year, in addition to our productivity opportunities. And a lot of those are around the purchasing side, completely independent from price. And though as well ramp up as we go through the year. So -- and almost sequentially. So Q4 is also significantly higher than what we're seeing in Q1.

And are you making any explicit call on kind of like the movement in these inflationary items, like the price of freight or the price of commodities, things like that?

We do assume that what we're seeing today pretty much continues through the remainder of the year, probably with a little bit of a throttle down in the fourth quarter. We think it could obviously get worse. Steel is up 115% in Q1 this year versus last year. If you listen to the experts out there, a lot of that price was based on a ramp-up in demand and a slower response from the supply as they kind of ramp up mills. So I think everybody anticipates that it can't get much worse from a steel pricing perspective, which is our most exposed commodity. But I guess it could. But we feel pretty good with the provision we've included in the forecast as it relates to commodities, and we do assume it pretty much extends through the rest of the year.

Got it. Okay. Any dynamics in the back half on mix, I guess services, if that kind of flips positive that, that could be a positive mix driver on anything on that front?

We -- there's 2 elements of mix we look at. We look at product mix, and we also look at regional mix. So certainly, we had a little bit of a headwind in Q1 from a regional perspective based on the significant growth in APAC year-over-year. That will update as we go through the year. But if you look at individual quarters, it likely is not going to be a significant player from a -- from a product perspective, we do believe that, I think in the first quarter, the critical infrastructure and solutions business was probably 50% of our total business last year. I think that ramped up closer to 60% in Q1. We don't see a similar dynamic through the remainder of the year, but as we're seeing, some of the additional sales we added to our guide are skewed a little bit more to that CI&S. So mix could be different each quarter, but we don't see it as significant as a headwind over the remainder of the year as we saw in the [Audio Gap]

Our next question comes from Andrew Obin with Bank of America.

So the first question for me on your IT channel. A big growth initiative for you guys. There's been some consolidation. How do you view Eaton's acquisition of Tripp Lite? Does it really change the end market that much, from your perspective?

Yes. Andrew, Rob Johnson here. I really don't want to necessarily comment on what the competitors are going to do or not do. We -- consolidation sometimes gives an opportunity for companies like ours to be able to be in that top 2 or 3 bidding perspective. So they usually like to have 3 bidders. And so I see that as a potential positive for us as we go forward. We're really focused on our innovative solutions that we're bringing to market, our thermal management and kind of that total solutions approach in the channel, which we think globally, we've got a really good position and strong there. So while not necessarily focused on Tripp Lite and Eaton, what's going on there, we're really focused on bringing those new products to market and driving innovation against our competitors to gain share. And as you can see in our IRS business, we did have decent year-over-year growth. We've seen that for the last several quarters now and expect to continue to see that grow as we introduce more products into that venue. And not all IRS business is in the channel. So it's not necessarily indicative of the channel because we do sell -- the C&I business as well falls within that channel space.

Yes. And then a bigger picture, and bigger-picture question, right? I mean if you think you have technology-focused global business, it does seem if you look at the legislative action, there are pretty big bills cooking up in Congress in regards to China, in regards to incentivizing technology R&D -- technology and R&D investment in the U.S. And it was your philosophy to optimize your existing manufacturing footprint, right, and just drive high and higher volume. Does this sort of change your thinking, the sort of bifurcation of the tech world perhaps into, I guess, President Biden uses the term techno-democracies and techno-autocracies. Have you guys thought about it? Does it change your approach to manufacturing footprint, your sourcing? A pretty open-ended question, but it seems there are sort of big headlines, at least, coming on this topic and you guys in the middle of it, just given what you do for a living.

Andrew, thank you for your question. I don't think it really changes. We're a little bit different than maybe some of our competitive -- companies out there have always been kind of more or less an in country-for-country or an in region-for-region. What we did do over the last couple of years from an R&D perspective is really drive to a matrix and put center of excellence all over the world, not necessarily in best cost locations, but in the right place to be developing those products. So I think you'll find both our R&D investments, which are [ pulling full ] in the U.S. and in the Americas and in Europe and in Asia Pac, and I think you'll find that fairly balanced. And so we were already doing that. I think COVID has taught us a lesson about second sourcing vendors and making sure that we have more in region, and we've made some moves based on COVID to be even more regional from that perspective, which probably plays in the hands of some of the stuff Biden is doing. But in general, I don't think that's driving our thoughts right now. But I feel really comfortable with the footprint we have from a development perspective. And as we look at how we do things, we're, in some cases, a highly-engineered product, and freight and everything is important in speed to market is important. So being closer to our customers, not just using an Asian source and bringing that in, it has been part of our strategy and will continue to be that.

Our last question will come from Nigel Coe with Wolfe Research.

So Andrew, strong points, so I'll take that quote up. So obviously, we're pushing well past the hour mark here. I'll keep this pretty quick. I want to go back to the pricing. You covered that very well. So I'm not going to retread any new ground here. But 20 bps of additional price doesn't seem like a shoot-for-the-moon scenario, but how does the backlog play into the pricing equation for the second half of the year? You've got $2.1 billion of backlog, it's about 2 quarters worth of sales, not quite 2 quarters. But are we thinking here that the price increases are mainly in the fourth quarter, given that backlog coverage? Or is there some mechanism in the backlog to push through some digital price?

Yes. Nigel, it's Gary. So I'd say the answer is mixed and varied. I mean obviously, it's a little bit easier to get price on new orders. But by no means are we just taking a look at that $2 billion of backlog and saying, well, there's nothing we can do. It's already in backlog. So we do have some other mechanisms, sometimes in larger contracts that have material clauses in them. Certainly, freight is another lever that we can utilize. That is a real-time mechanism. There's been times when we've instituted surcharges as well. So I would say that, yes, it's easier to get price on new orders coming through the door. But by no means are we going to just discount the $2 billion that we have and say there's nothing we can do there. We're looking at that, taking action on that as well. With all that said, I do think price probably continues to ramp throughout the year, as David mentioned earlier. So I think in general, that pricing will ramp. But those are the different ways we're looking and trying to execute that pricing and freight scenario.

That's great. And then my follow-on question is around market share. And we don't really have a lot of good information from your competitors in terms of their growth rates. It's always double-digit growth and strong growth but there's no quantification. So I'm just curious, obviously, you see the bids and quotes in the RT activity. How do you feel your share is tracking relative to the last 2 or 3 or 4 months? And where do you think you're gaining or even losing share?

Nigel, this is Rob. I'll start and then let Gary follow in. And one thing I think all of us on the call need to remember is, typically, people talk about a couple of the big 3 or 4, but as you look at the pie charts we've shared in the past, there's a lot of gray area, which is smaller, more regional players that play into this from that perspective. So you got to be careful just watching us versus some of the other competitors that are our size and really look at how we think about things, and part of our strategy was taking share from those more local mom and pop, where we failed to innovate early on or provide a solution and now can provide a solution and provide that globally. So I think we feel -- across the board, we feel really good about where we're at from a thermal position and from a power position as well. And again, you'll have some local players that we go up against, and then we'll go up with some of the global players. But overall, we -- with our strong growth that we've actually posted the last couple of years, we think we've been outpacing the industry, which would mean that we either get more of our fair share and taking some share from that perspective. But when you look at kind of a broader question, is there's a whole another 50% of the pie that's made up of a bunch of small mom-and-pops, pieces that are moving around. I don't know. Gary?

Yes. Nigel, I think Rob said it beautifully. Just analytically, you're right, that's sort of the maddening -- one of the maddening things about the market is you can't just peg it to a specific number of is this what the market grew or shrank. To the best of our ability, if you go back to '19, we think the market probably grew low to mid-single digits and 3%, 4%, and we grew at 6%. And then if you take a look at last year, the best sources, we think that the market probably shrank 4%-ish, and we were down 1 point organically. So you take those 2 different data points and you say, okay, it's consecutively back-to-back years now, we think we've pretty squarely outperformed the market by that 1.5x goal that we've established. And certainly, with the strong start to Q1, don't have any signs of letting up at this point by any means.

This concludes our question-and-answer session. I would like to turn the conference back over to Rob Johnson for any closing remarks.

Well, thank you, and I appreciate everyone attending our call today. As you can tell, we're really excited about the Q1 results, but really the go-forward and the execution of the strategy that we set out and shared with all of you, and we'll continue to drive that as we go forward. Again, I appreciate that support. Thank you, and have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.