Vertiv Holdings Co (VRT) Q1 2022 Earnings Report, Transcript and Summary

Good morning. My name is Joe, and I will be your conference operator today. At this time, I would like to welcome everyone to Vertiv’s First Quarter 2022 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.

Thank you, Joe. Good morning, and welcome to Vertiv’s First Quarter 2022 Earnings Conference Call. Joining me today are Vertiv’s Executive Chairman, Dave 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 moments of Vertiv. These forward-looking statements are subject to material risks and uncertainties and that could cause actual results to differ materially from those in the forward-looking statements. We refer you to the cautionary language inclusion in today’s earnings release, and you can learn more about these risks in our annual report, 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 press release and in the investor slide deck found on our website at investors.vertiv.com. With that, I’ll turn the call over to Executive Chairman, Dave Cote.

Good morning. We do recognize our first quarter guidance was a low bar. However, it’s also important to note that we did better than that. We’ve been addressing key shortfalls, including execution of an aggressive pricing plan, taking a realistic look at inflationary pressures, creating a more action-focused America’s culture, and changing management in areas of the business that did not execute well. As I mentioned on the last call, I’ve been more personally involved in the business as we work our way through some of the near-term challenges. The actions we’ve taken has started to take hold, and we see the benefits playing through. The pricing realized in the first quarter of $40 million exceeded our plan by $10 million. This gives us some confidence we are on track to deliver the pricing plan for the remainder of the year. We’re comfortable with what we see in Q2 so far. Demand backdrop remains very favorable. We anticipate even more pricing playing through the P&L, as we continue to burn off more of that lower-priced backlog. The real test will be in Q3, when we expect to see the significant positive impact from our pricing actions that we’ve already taken. And Q4 will more fully reflect our run rate adjusted operating profit that sets the stage for a strong 2023. While this has been very painful for everyone, I believe the actions that have been taken, especially related to price, position us well to perform in the second half and next year. We’re taking this a quarter at a time, we cleared the Q1 hurdle, and we are on track for Q2, which will be a step up from Q1 performance. We still have to prove to you that we can do this, and we are squarely focused on taking appropriate actions to make sure we do that. So with that, I’ll turn the call over to Rob.

Thank you, Dave. It’s all about our execution, and we understand that. Q1, as Dave said, was a first step, and we’re driving incredibly hard to make sure we deliver on our commitments going forward. Starting with some key messages on Slide 3. I’ve said this for a while. Demand remains very strong. In simple terms, data growth drives our business and everywhere you look in business and in everyday lives, everything incorporates data, and Vertiv plays an essential role in making sure those vital applications in society stay up and running. Our orders were up 34% in the quarter, even considering significant price increases that were put in place in late 2021 and early 2022. We are relevant with our customers. The order rates are a good scorecard for the market share and clearly demonstrate we are winning in the marketplace, in addition to reinforcing that more pricing is possible. As Dave noted, we exceeded our first quarter guidance. As anticipated, our adjusted operating profit was under pressure in the first quarter, but we are encouraged by the overdrive on pricing performance and inflation lower in the quarter than expected. That said, with lessons learned from last year, we are taking a prudent approach relative to inflation assumptions for this year. Even though we did better than anticipated in Q1 on pricing and inflation guidance assumptions, we are increasing the overall inflation for the rest of the year of $25 million. We are also taking additional pricing actions, but have not included that benefit in our guidance. Due to our large backlog that needs to shift, we expect to see more of this additional price show up in 2023. While it’s hard to predict inflation and price this early in the year, we are taking a reasonable approach in light of what we are seeing. We have modified our second quarter guidance to reflect some pull ahead of sales in Q1. For Q2, we expect to continue to see some short-term delays from COVID-19 shutdowns in China. These are timing-related shifts that are not unexpected given the dynamic macro backdrop. Supply chain issues are still a challenge. Our pain points continue in these areas of electronic parts, fans and breakers. We are not sitting idle. We are working daily on countermeasures to help us address these challenges and expect that the challenges will continue through 2022. As mentioned earlier, 2022 is all about execution. We are on track with the plan we presented for this year. As mentioned, Q1 came in slightly better. We feel good about our trajectory of the quarters ahead, allowing us to deliver a strong second half and putting Vertiv in a very, very good position for 2023. Turning to Slide 4. This slide summarizes what we see in the market by region. There’s no change in our cloud and hyperscale market. Strength continues in Americas and EMEA. The dynamic in APAC remains the same as we described previously. China cloud and hyperscale companies are working to utilize existing capacity to slow down energy consumption. We expect this to be a short-term phenomena, as data continues to grow in China and globally. The colocation market continues to be very strong in Americas and EMEA. This can also be a read-through to hyperscale strength that often use colocation as capacity for hyperscalers, both internationally and need for capacity in Americas. We do see colocation in parts of Asia slowing, driven by the same dynamic in China, as just described in the cloud market. Our view of the enterprise and small and medium market remain consistent from Q4, with particular strength in Americas. The communications market remains strong as technology upgrades continue, especially in 5G deployments that are driving our activity. In the commercial industrial market, things remain consistent with previous view as well, and we see good opportunities in this space, as a number of vital applications continue to proliferate. Moving to Slide 5. As mentioned, market demand remains very strong by our orders growth of 34%. The secular drivers of our end market remain firmly intact and seem to be intensified. The proliferation of data continues at an extremely rapid pace. This creates the need for additional capacity, and we are happy with our position as a pure-play in this market. I also would say, Vertiv has key differentiators that customers do value. We have always been a technology company, and our increased investment in R&D has provided innovative solutions. We see the product differentiator does matter to our customers, and we are now getting paid for that. Some examples of this is our new DSE thermal products that do not use water and are highly efficient. Another example of innovation has been our launch of our new GXT family of lithium-ion UPS systems. Along with the standard products that we deliver to market, we know that customers have specific needs, with engineering needs for modular to solve their problems. We work hand-in-hand with our customers, not only to provide standard products, but to provide custom products that fit their needs. I’m very encouraged by our pricing realization of 4% in the quarter, which was largely based on backlog booked in 2021, including pass-through pricing of things such as batteries and trains [ph]. We saw positive price in all regions, including China. We realize we still have a big hill decline for the second half, but we have taken an aggressive pricing actions to deliver the plan this year. We are on track to deliver the pricing plan for the year. First quarter as an important indicator of our ability to get price. Supply chain, as I said earlier, continues to be a battle every day and has constrained our ability to ship product. The global commodity markets have been negatively impacted by the war in Ukraine. Relative to our guidance, we were favorable to the inflation plan for the first quarter. As I mentioned earlier, we are taking a prudent approach to the inflationary environment, and we’re adding $25 million more inflation into the plan for the balance of the year. We have teams at Vertiv working diligently to qualify new suppliers and redesign products to alleviate some of the most critical pain points that we have. In summary, markets remain very healthy, and I feel good about our order rates that continues to be strong, even after implementing aggressive price increases globally. Supply chain is a challenge, but we’re working through many of these different with various strategies to navigate the tough environment. Now, I’ll turn the call over to David to walk through the financials. David?

Thanks, Rob. Turning to Page 6. This slide summarizes our first quarter financial results, which exceeded our guidance we provided at the end of February, as Rob mentioned. Net sales were up 5.3% from last year’s first quarter and slightly up organically at 0.4%. There was an $88 million benefit from the E&I acquisition, a $15 million headwind from the divestiture of our heavy industrial UPS business, and a $20 million headwind from foreign exchange, primarily in EMEA. We are encouraged by the $40 million pricing benefit in the quarter, as both Dave and Rob mentioned, and that $40 million exceeded our forecast by approximately $10 million. Most of the backlog that shipped this past quarter was booked in 2021, prior to the additional price increases implemented late last year and early this year. So this is a good signal that our initial price increases are sticking, and we should continue to see our pricing translate into bottom line going forward. Adjusted operating profit for the quarter of $13 million was above guidance, primarily driven by $10 million of additional price and $15 million lower material and freight inflation versus what was assumed in the guidance. Versus prior year, the $99 million reduction in adjusted operating profit included the $40 million pricing benefit, as well as a $9 million benefit from E&I, which was more than offset by $85 million of material and freight inflation. We also had headwinds from foreign exchange, labor inflation and commissions, which actually came in below our expectations for the first quarter assumed in the guidance. Along with impacts from lower volume, a $10 million incremental investment in ER&D. We still expect price/cost to be neutral in Q2 and a significant tailwind in the second half of the year, as we will discuss in our guidance slides. Adjusted operating margin was 910 basis points lower than last year, and adjusted EPS declined $0.29, both reductions consist with the adjusted operating profit deterioration. Finally, on this page, first quarter free cash flow was significantly lower than last year’s first quarter. The business is typically a user of cash in the first quarter, but we are negatively impacted by lower operating profit and higher inventory this year, with inventory up about $160 million from year end. Although we normally build inventory in the first quarter, we expected a $60 million to $70 million increase. We were negatively impacted this past quarter by both large project timing. And as we mentioned on our previous earnings call, an imperfect SIOP [ph] process in the Americas, which drove an inventory increase much higher than our internal expectations. We unnecessarily built inventory in the Americas based upon a higher sales plan, which drove the purchase of significantly more raw material than needed to satisfy first quarter shipments. We continue to address interlock issues within the Americas SIOP, and as a result, we believe that inventory in ship will balance out over the remainder of the year, consuming most, if not all, of the first quarter inventory build. The negative cash impact from higher inventory in the first quarter versus our internal expectations was offset by better-than-expected EBITDA and higher cash inflow from deferred revenue, resulting in first quarter free cash flow in line with internal estimates. And last on this page, liquidity at the end of the quarter remained strong at $720 million. Next, turning to Page 7. This slide summarizes our first quarter segment results. The Americas region continues to see outsized impacts from supply chain and net price cost challenges. The supply chain challenges constrained the top line again in the first quarter, with $17 million of organic growth or 3.3%, driven entirely by price realization, and we anticipate price will continue to be a main contributor to organic growth throughout 2022. Americas adjusted operating profit of $58 million was again dragged down by price/cost, but we anticipate that relationship moving to neutral to favorable in the second quarter, and providing a nice tailwind in the back half of the year given our strong pricing response in the Americas. Moving to APAC. Organic sales were down 6.7%, primarily due to lower wind power sales and COVID lockdowns in certain parts of China. Adjusted operating profit of $42 million was down $11 million versus prior year, primarily due to deleverage on the lower volume, as well as unfavorable mix. Price/cost was neutral in APAC in the first quarter, as we continue to see lower levels of inflation reading through the APAC region. Moving to the right, EMEA continues to lead in regional growth, with organic sales up over 5%, with a good portion of that coming from price. The price cost headwind in EMEA accelerated in the first quarter, a trend that commenced in December and has been further negatively impacted by higher cost of certain commodities resulting from the Ukraine war. We have implemented aggressive pricing actions in EMEA as in all regions, and expect price cost to provide a nice tailwind in the second half of 2022. Next, turning to Page 8. This slide provides an updated look at our second quarter 2022 guidance, very much in line with our previous guidance. We believe the second quarter will be the next step-up in financial performance as we execute our plan to deliver a strong second half of 2022. It is our next hurdle to clear, and we feel good about the core assumptions in the second quarter plan, including inflation and pricing assumptions, which are unchanged from previous guidance. We anticipate net sales to be up 6% from last year’s second quarter, with organic sales flat on lower volume offset by pricing. Our expected adjusted operating profit of $70 million to $90 million assumes neutral price cost in the second quarter. Turning to Page 9. This slide summarizes our full year guidance for 2022. Like Q2, our full year guidance is largely unchanged from what we previously provided, with some timing adjustments resulting from our first quarter beat. We are holding our full year assumptions rather than letting the upside from Q1 flow through. We have a challenging, but manageable hill climb in the second half of 2022 and are committed to making sure we deliver that plan. We reiterate the adjusted operating profit guide of $525 million at the midpoint, and we feel good about this plan and the key assumptions included. Delivering the second half will set us up for – set us up very nicely for a strong 2023, and we are laser focused on critical levers to make that happen. Next, on Slide 10, we provide an update of the quarterly sales guidance compared to our previous guide. This effectively updates the slides we illustrated in our fourth quarter call. Our February guidance is noted at the bottom of the slide and our updated guidance is at the top of the slide. We have reflected slightly higher sales for the full year, primarily in the second half, driven by higher expected volume and a smaller expected headwind from foreign exchange. We continue to expect a volume ramp as we progress through the year. This is the normal historic pattern, but we also expect some of the work we are doing on redesign and qualifying new suppliers to take hold, and we expect to see some incremental benefit from those actions, which will support the additional second half volume. Still, an overall conservative estimate on volume this year that we will continue to assess, but we are mindful that supply chain challenges are not expected to abate anytime soon. Turning to Page 11. This slide is an update of quarterly adjusted operating profit guidance. Again, the previous guidance from February is noted at the bottom of the slide, and the updated guidance provided today is at the top of the slide. We have provided ranges for adjusted operating profit for each quarter for the remainder of the year, with the midpoint for the full year remaining at $525 million. Price cost will be the biggest driver to sequentially improving quarterly performance, and we have confidence in our ability to realize the pricing plan based upon what we have realized year-to-date and what we see in the order book. Quarterly price cost assumptions are summarized as we turn to the next slide, Slide 12. Our first quarter guidance assumes negative price cost of $70 million, while we actually delivered negative $45 million, with price and inflation both favorable compared with our first quarter assumptions. We have maintained assumptions for neutral price cost in the second quarter, while we have increased expectations for inflation in the second half by $25 million, as there continues to be significant uncertainty with both material and freight inflation, notably in the Americas and EMEA. We are working diligently to avoid situations like last year, where we were chasing a growing inflation number for most of the year. We have also initiated additional pricing actions, given this higher expectation for inflation in the second half, but given the long backlog industry-wide, we are not relying on that materially impacting 2022. For the year, we anticipate price cost being a $90 million tailwind, including $135 million tailwind in the second half. This tailwind will set us up very well as we turn the corner into 2023, further enhanced by the year-over-year wraparound impact of our aggressive price actions. Finally, for me, it’s very clear we are working hard to repair the credibility that was damaged with our Q4 performance. Q1 was the first step in doing that, and we will continue to provide detail on our assumptions and projections to allow for a transparent dialogue on how we are progressing. We know you’re watching closely, and it is on us to make sure we execute well and deliver that 2022 plan. With that said, I turn it back over to Rob.

Thanks, David. And just to reiterate what you said there at the end, first quarter was the initial step in delivering the 2022 plan. We did what we said we were going to do and are working hard, as David said, to earn back the credibility and really unleash the value of this business. The value drivers of this business are very much intact, and in many respects, being accelerated. We have worked hard to address the key shortcomings from Q4, as Dave mentioned, including taking aggressive price actions, enhancing our Americas culture, making changes in key management positions and implementing core business process improvements. The key actions to make the 2022 plan have been put in place, and we’re encouraged by the progress to date. I have confidence we’re on track to deliver in our full year commitments. As we deliver on these commitments, this will set us up very nicely for a nice 2023. We are determined to accomplish this, and I take this personally to make sure this happens. With that said, I want to thank you, and I’ll turn the call over to the operator, who will open up the line for questions.

[Operator Instructions] The first question comes from Jeff Sprague with Vertical Research Partners. Please go ahead.

Thank you. Good morning, everyone. Just a couple of pricing-related questions for me. Just first, could you address in, a little more detail, price on orders and if there’s any way to kind of frame that relative to kind of how margin and backlog is developing? I guess kind of the underlying question is, there’s a little bit of uneasiness here that the orders are "too strong" because there’s not enough price in the orders. So maybe, we could start with that.

Jeff, this is Rob. I’ll address your second part of the question first, and then David will come in over the top. But I would say that if you take out two very large orders that we had, which we did get price on, our orders growth rate was about 12%. That being said, you are correct that we believe, and we’ve mentioned that earlier, that there is still more price to be had. As we do this, and we said we are and continue to do that throughout the year, we’re going to do it more specific to where product lines and areas are growing, where we have the ability to deliver and where we have differentiation. So, we do believe there’s more price, but in the 34%, there was two very, very large orders that had year-over-year price that we were very happy with, which would have taken that orders rate down to 12%. But that being said, we believe there’s more price there, and we’ll go after it. David?

Yes. And just to quantify some of that, heading into this year, in order to hit our 2022 plan for price and AOP, we had five mid-single digits pricing in the backlog heading into 2022. But we also realized we needed to get low double-digits as it relates to pricing on book and ship orders. So those are the orders that we’ll progressively ship in Q2, Q3. And I think 85% of our shipments in Q4 will be based on book and ship, so orders that we book post 12/31 2021. And we are very much on track to realize that low double-digit pricing, low teen pricing in orders that we booked so far this year.

Great. And then, on the kind of the shorter-term pricing. Is there more scope there on kind of shorter cycle parts of the business in the channel? And I think you typically pass through battery, which was part of the equation, but have you done something incremental on freight or other surcharges that are kind of truing up the numbers and give me a little bit of additional cushion here relative to what you originally thought?

Yes. A couple of areas to – you mentioned channel, and channel continues to be one that we watch and we’ll continue to look at various product lines there as well, and it could get – continue to get price as it relates to the channel, that’s typically a faster moving in quarter, but – or at least a quarter to ahead. Other areas of surcharges, you mentioned, on freight. We’re better at driving that and passing that along. And then I would say, the other area that we talk about that more shorter cycle is service and service renewal contracts. So those are some other levers that we have and continue to utilize as we drive for price.

Great. Thanks. I’ll pass it on.

Mr. Spragg. I hope you noticed that we – third time through, we got your name right.

Yes, your question at Mr. Cote. Thank you very much.

The next question comes from Andy Kaplowitz with Citigroup. Please go ahead.

Good morning everyone.

Good morning.

Can you give us a little more color into your commentary regarding Q2? As you said, your sales and operating profit guided slightly lower than your original guide, so how much in the way of sales was pull forward? And can you talk about the delays in shipments you’re seeing given China lockdowns? What’s the risk to get where versus getting – get better? And how have you factored that into your guide?

Yes. Thanks, Andy. So overall, we took sales down in Q2 by about $5 million. About $15 million of that was volume, some was pulled into Q1, but some was also pushed into Q3. Now, we did take overall volume up for the full year, and a lot of that is sitting in Q3. So the increase in Q3 is more than just the push from Q2. But in Q2, we also had benefit from lower foreign exchange than we anticipated. And we also took E&I sales up about $5 million. If you look at the overall adjusted operating profit takedown, that’s about $10 million at the midpoint. So, we had previously guided at $90 million in our range, currently, is $70 million to $90 million, with $80 million at the midpoint. About half of that is related to that $15 million lower volume and the other half just relating to timing of some fixed costs.

Thanks for that. And then maybe, just shifting gears, a little more color into inflation expectations. You obviously increased your provision for the year by $10 million. I think you had that run rate of $160 million, you moved up to $110 million from $100 million. You mentioned the changes as a result of uncertainty in commodities, freight, but you’re also being more prudent. Have you seen more issues crop up yet? Or is this just more of a preemptive call given the volatility of the global supply chain?

Yes. I think that the key word in your question is uncertainty, and I’m sure you’re hearing that on every call. We did beat the inflation number implied in our guidance for Q1, but we certainly are not celebrating. We overlaid $100 million at the beginning of the year in our guidance versus what the carryover impact was. So that’s the math you’re talking about. So we had $160 million of carryover and – $100 million of additional inflation. We used $10 million of that in the first quarter. It resulted in a beat, but we also understand the dynamics of inflation and especially where we are today, it generally accelerates. And what we have done for that overlay, we have increased the full year from $100 million to $110 million, and we also retimed the impact of that $110 million. So in our previous guide, we had assumed a flat $25 million per quarter. And we told everyone we would update that after the first quarter, after we understand the updated dynamics. But in our updated guide, that $110 million is now time, $10 million in the first quarter, $25 million in the second quarter, $35 million in the third quarter and $40 million in the fourth quarter. So that’s definitely reflective of our anticipation of the possibility of inflation to continue to ramp up. And we generally talk about inflation in two buckets, material and freight, and to anticipate a question on the first quarter beat, most of that was in material. And the freight inflation we saw in the first quarter, notably in the Americas and also, to a certain extent, in EMEA, was higher than we expected. So, we certainly think there is risk and uncertainty across both material and freight, but certainly, the freight aspect of what we saw in the first quarter was higher than we anticipated.

It’s helpful. Thank you.

Our next question comes from Scott Davis with Melius Research. Please go ahead.

Good morning guys.

Good morning Scott.

I wanted to just to dig in a little bit, take a step backwards and talk about mechanically how you get price. There’s a couple of different ways to do it. You can kind of brown people where you can change compensation schemes. You can command and control. But how are you guys kind of doing the push pull on getting the sales force aligned and getting of your compensation schemes and everything aligned so this isn’t – this doesn’t come back and haunt you in a few years?

Yes, Scott, this is Rob. I’ll start first of all, a couple of things we do to get price. Certainly, there’s an approval process. I think we talked about this before that under certain multipliers in which people try to sell the product, they can go and adjust price for the customer. We’ve tightened up those approval processes and taken those to a much higher level. For example, David and I are seeing much lower dollar on amounts that we are approving. So we taken the management team across the globe and really, have driven that pricing acceptance to be there. So we can control of that. And that’s how we know we’re going to get price from that perspective. And depending on where we are in the world and how the sales team and or the teams are getting compensated, I’ll give you an example. A large portion of our U.S. compensation through our partners and so forth is they get paid more if we get paid more. So it really is in their best interest to go negotiate more. But each part of the market is a little bit different. When we go to pricing, our service contracts, our spare parts, we look at each one of those and understand what we need to get, what we believe inflation could be and then price above that. And quite honestly, I think the market and our customers have understood, it’s not necessarily a price thing now, its availability thing and it’s the ability to get it. So that environment has helped us as well drive through it. But I’m confident where we are today, with our pricing process, with our review process, which incorporates the entire management team on a weekly basis. We look at new orders coming in, we see it come. While we haven’t we can’t jump up and celebrate and say, we’ve beaten it, and we’ve got it all done, we feel very confident that we’re going in the right direction.

Okay. That’s helpful. And then just as a follow-up...

Scott?

Yes, please.

If I could just interject. I would say, at least, in my history, the prospect of getting price increases on a decentralized basis through comp schemes or telling the sales forces is something they need to get really, have a low success rate. And one of the reasons that Rob and his team are being successful here is they have largely centralized control. Whether it’s dictating what the price increase is, the multipliers, approving deviations and just not letting any of that come through. As sales forces in general are your worst enemy when it comes to trying to get a price increase. And it’s that more centralized drive with dictates as to what it will be and making sure it’s showing up in orders pricing is making all the difference for us.

That’s really helpful. My second question isn’t not good. So I’m going to pass it on to the next guy. I’ll talk to you guys later. Thank you.

Thanks, Scott.

Thanks, Scott.

Our next question comes from Steve Tusa with JPMorgan. Please go ahead.

Hey guys, good morning.

Good morning, Steve.

Good morning, Steve.

Sorry, not sure my question is going to be much better, but – the carryover now on kind of price costs into next year, does that incremental inflation this year tempered all your view of what happens next year with the run rate off of the 4Q margin that I think you guys have talked about?

Yes. I would say, the way we handicap that internally. So we talked about a $200 million carryover impact for pricing into next year. Based on some of the additional pricing actions we’ve taken just in the last two to three weeks, I would certainly take the over on that $200 million. As it relates to inflation, I think that’s still uncertain, but there likely would be some carryover impact there. But net-net versus what we were expecting internally, just 60 days ago for 2023 is unchanged, right? The bottom line for Q3, Q4 remains relatively consistent, and that’s going to set us up for a very strong 2023 regardless. And the bottom line is if inflation continues to go up, we’ll continue to price for it. And we’re very confident we can do that based on what we’ve seen over the last 90 days or so.

What’s the variability to the margins, if you guys miss on volumes in the second half? You have a bit of a step-up there on volumes. If that doesn’t come in, like, what’s more important? The price kind of cost scenario or the volumes for every kind of percent of volumes, what should we kind of assume the drop-through would be on the miss?

Yes. So our – we talked a lot about variable contribution margins historically. And historically, those have been in the 40% range. Based on the price cost dynamic we’ve seen over the last year or so, and it’s going to continue at least through Q2 – being neutral in Q2. It’s probably in the lower 30s, and for every dollar of lost volume, we would lose in that $0.30, $0.35 range of AOP.

Right. Okay. Thanks. Appreciate it.

Yes.

Our next question comes from Amit Daryanani with Evercore. Please go ahead.

Good morning. Good afternoon. Thanks for taking my questions. I guess the first one is, I’m hoping you can just talk a little bit about the free cash flow number for the quarter. I think it was negative $150 million. It was below what I had modeled, at least. I would love to understand how did that stack up versus your expectation? And then do you sort of expect free cash flow to be positive for the remainder of the next three quarters to hit your 2022 targets?

Yes. So the $150 million was almost spot-on with our internal expectations. Now, there are some puts and takes, and we talked about one in the prepared remarks with inventory. So inventory came in higher than what we anticipated, and we’re working on the issues there. But we did get favorability as it relates to the profit performance or the cash impact from EBITDA. And also, we had favorability related to upfront cash in the door from customers, which shows up in the balance sheet as deferred revenue. So that $150 million number was consistent with internal expectations. Now, for the full year, we still are comfortable with the $150 million positive guide. If you look at that from a quarterly basis, we do anticipate a another cash burn in Q2. It should not be as high as what we saw in Q1, but we do anticipate significantly positive free cash flow for both Q3 and Q4.

Got it. That’s really helpful. If I could just follow up. Your perspective on sort of the implications from China locked out or part of China getting locked down. I know your APAC revenues were down 6%, 7%. So maybe, you just touch on what’s the implication of that from a demand perspective? And then perhaps, importantly, are you seeing any supply chain implications from parts of China being shut down as well?

Yes. Rob Johnson here. I’ll start off. On the China situation, we’ve – anticipation, Shanghai has been shut down. Shenzhen, where we’re headquartered is now opened back up again. Shanghai is where a lot of the ports are for exporting. We’re watching that carefully, but we believe that we can’t predict what’s going to happen with the COVID lockdown. We believe that they’ve gone through a pretty rigorous process. And towards the second half of Q2, things will open up and we’ll see additional shipments. So APAC, really two things that impacted. One was COVID and one was some of our wind power business, which can be come in cycles from that perspective. But we – like I said, can’t necessarily declare victory on COVID, we’ll see what happens there. But in general, our expectations that we’ll pick up, anything that’s happened in March and April. I’ll pick that up in later May and June.

Perfect. Thank you.

Thank you.

Our next question comes from Nicole DeBlase with Deutsche Bank. Please go ahead.

Yes, thanks. Good morning guys.

Good morning, Nicole.

Hi Nicole.

And so just maybe to talk a little bit about what you’re seeing in Asia on that slide where you guys went through like the green and yellow bubbles. I know colo, it makes sense why you’re moving it to yellow. But I guess, when you guys see these digestion periods, in Asia, how long does that typically last? So over what timeframe can we maybe return to green?

Sure. So there are a couple of dynamics I’ll start with, and then Gary can give you probably some more color. As we look at Asia, we break China out, we just talked about kind of COVID and the absorption of the current data centers. I mean, China has put a big plant down on building new data centers until the current data centers get utilized. I think that’s a quarter or two phenomenon, maybe, a little bit longer, it could go through the end of the year. As it relates to – which is part of our AsiaPac story to India, we see actually strong growth there in colo and hyperscale. So just kind of separate that out, that’s an area of what we’ll see, call it, extreme growth going forward, and we’re in a good position there. Singapore has done is kind of similar to China where they’ve kind of kind of locked down on the number of data centers build, get the utilization up, get the PUEs up. So there’s some dynamics there. And again, that’s short-lived, a couple two or three quarters, but that’s kind of our perspective. I don’t know, Gary, any other thoughts?

Yes, I think that’s exactly right, Rob. Hey, Nicole. The only other comment I’d add to what Rob said is what we’re finding and what the team is pivoting towards really rapidly, as even in those areas where maybe, they’re not doing as much green bill, there’s an awful lot of upgrade retrofit brownfield work that is being done there, which is really good for aftermarket for service for all of these other ideas that we can take to market now. So maybe, that the large power, large thermal business suffers in China a little bit, but we should see a really active service retrofit, things that we can do to an existing facility to help them up their PUE. That’s where a lot of that offset is going to occur.

Okay. Got it. That’s really helpful. Thank you. And then, just maybe, a shorter-term question. When you guys put together the 2Q outlook, just anything you’d highlight with respect to growth or margins by region that we should be considering like with the bifurcation of the regional performance. Thanks.

Yes. So overall organic sales are flat to prior year. If you look at that from a regional perspective, the overall organic growth is probably going to be outpaced in APAC and positive and EMEA, Americas flat to down, right? And – but price will be positive in each of the three regions. What is driving that overall sales difference is related to the volume, with volume up in APAC and volume likely down in the other two. From a price cost perspective, in Q1, APAC was neutral and the Americas was about $35 million negative and EMEA was about $10 million negative. If you fast forward to Q2, overall, we’re anticipating to the neutral price cost versus the second quarter of last year. And likely positive in both Americas and APAC and slightly negative in EMEA. So not – from a price cost perspective, not really significant differences across the three regions.

Thank you.

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

Yes. Good morning.

Good morning Andrew.

Good morning Andrew.

Just the first question, and look, I absolutely am aware of your Chairman’s reputation for delivering the numbers, Dave. But just to understand your guidance, so you did very well in Q1, but if I look at Slide 11, Q2 operating numbers, operating profit, the midpoint was cut by 10%, Q3 by 5%, Q4 by 5%. You sort of talked about the commitment to the numbers. And I just want to understand, is it just pure conservatism? Or how much margin of safety is there in this guidance versus, what you guys have given us to February? Because the tone I’m picking up is that it does sound like it’s pure conservatism. Yes, things have gotten better, but you had enough cushion in the original guidance that you just don’t want to raise for the year. Sorry to be so blunt, but I’m just trying to understand what the messaging here.

I don’t – semantically, I’m not sure what the right words are, but we’re certainly being cautious. We have reasons to be optimistic based on our Q1 performance with both pricing and what we saw with inflation. But as I mentioned earlier, we’re not celebrating the inflation performance, because we saw what happened last year when we consistently underestimated what we saw with the inflation. And that is our caution. And in any regard, it’s hard to take the first quarter and make broad assumptions with what the full year is going to do. And that’s in a so-called normal year. So we certainly don’t want to get out over our skis based on what we did in Q1, and we still remain very optimistic about hitting the full year plan. But we have introduced caution, and I think you see that with our assumptions for inflation. We beat by 15, but we took the back half up by 25. And some are looking at that as a – and I’ve heard the words cushion used, and we do not see that as a cushion. We see it as a provision for the possibility of higher expected inflation. At the end of the day, we don’t know, but we think it’s the prudent thing to do from a macro perspective.

Yes. Look, I just want to make clear. I appreciate the track record of the operating team and your Chairman, so I don’t want to dismiss that. Question number two, are you seeing any incremental decommits from suppliers? And just – I’m thinking about motors coming out of Germany, given what’s happening in the Ukraine, China COVID lockdowns, just to understand that? Or have things smooth out there? Thanks so much.

Yes, Andrew, this is Rob. No, we’re not seeing any incremental decommits. And the way we kind of set the year was based on what suppliers could deliver in Q4. So that’s why, again, looking at not necessarily what they’re telling us they could deliver, but what they’ve actually delivered. And that’s how we really set our plan. So we’re – there’s various things here and there, but for the most part, some of the big things we’re talking about we think we’ve got it at a steady state. And at some point in time, things will get better. Chips are going to take time, that’s going to be into 2023, late 2023, maybe 2024. Other things we’re working through alternative solutions on fans and other things like that. So as we get more diverse supply base, we’ll have a better ability to even shore up any potential decommits because of some world disaster or something. We’ve got hit and punch with a lot of different things last year and continue to see some of those. But for the most part, we feel good about where the supply base is as of today. And we’ve taken a realistic approach and what they’re capable of doing.

Appreciate it. Thanks a lot. Good luck.

Thank you, Andrew.

Thanks, Andrew.

Our next question comes from Mark Delaney with Goldman Sachs. Please go ahead.

Yes, thanks very much for taking the question. The first is on pricing of the $360 million of pricing assumed in the 2022 revenue guidance, I think as of the last earnings call, $125 million of that had been already booked and was in backlog, and there was $235 million that you still needed to book a higher pricing and on a schedule for 2022 delivery of that $235 million, can you give us an update on how much of that has been achieved? And is there any store remaining that’s needed to be booked at these higher prices?

Yes. Thanks, Mark. We can give an update on that. So your numbers were spot on. So heading into the year, we had $125 million in backlog, $235 million was go get in book and ship. If we snap the chalk line at the end of Q1, of course, we had $40 million in actuals. And we also were able to actually include additional pricing in backlog from orders. So at the end of Q1, we had about $155 million of pricing in backlog that we would realize over Q2 through Q4. And then we had $165 million that is the go-get and book and ship. So if you take the $360 million, that hasn’t changed. We have $40 million in actual, $155 million in backlog at the end of Q1, and the book and ship number is $165 million for the full $360 million.

Got it. Thanks, David. And my follow-up question was on the inflationary environment and what you’re seeing for cost. If I understood correctly, as of the last earnings call, the $260 million of cost inflation that was assumed for the year, it was $160 million based on what you were seeing at spot, and then there was $100 million that was just buffer for potential future cost increases. Now, at $270 million, I wanted to check on the composition of that and clarify one, is the $270 million reflecting spot? Because we’ve seen some big moves up in things like steel and freight, so I did want to make sure that is reflected in this $270 million number. And then the second part of it, is there any conservatism now for cost increases, maybe you haven’t seen? Or is there – there no more buffer and is just based on the spot moves? Thanks.

Yes. I think it’s a combination of what we’re seeing today and the expectation that inflation should continue to accelerate. So the $100 million provision we had for new inflation in 2022. We increased that debt to $110 million, but as we mentioned, of note is the timing. So we had about $10 million of favorability in Q1 – I’m sorry, $15 million of favorability in Q1, but we took the back half of the year up by $25 million. Now, we do have some internal breakdowns of where we expect to see that from a regional perspective and a breakdown between material and freight, but we certainly are – understand the fungibility and the uncertainty as it relates to inflation. So we certainly have provision, and we do not use terms like cushion or buffer as it relates to our approach to this inflation. We are assuming that this is going to happen, and that’s very critical and key for us as we continue to price for it. So we’re all hopeful, and I think every company out there is hopeful that inflation does not accelerate from where we are today. But we are not making that assumption. We are going to continue to assume that it gets worse. And if you look at that ramp of that $110 million, as we mentioned, we used $10 million in Q1. We’ve provided for $25 million in Q2, $35 million in Q3 and $40 million in Q4. So we will be happy if things do not end up like that, but we are absolutely assuming that it will.

Okay. Just a brief follow-up on that just to make sure I understand this. So even if steel to be sustained at the kind of spot prices it’s been at recently and the cost of shipping things around the world stays at these levels or perhaps, even gets a little bit worse, you guys still feel like your cost estimate for inflation this year is appropriate?

We certainly don’t have a crystal ball, but based on what we are seeing today with inflation, we are very comfortable with that $110 million. Are there scenarios that could come in higher? Absolutely. We saw that last year when we were trying to handicap probabilities of higher prices. But we are certainly expecting continued acceleration, but we believe what we have provided for in the $110 million should cover a realistic expectation of inflation for the rest of the year.

And Mark, we’ll continue, as we mentioned. Pricing isn’t a one-and-done thing. It’s a daily weekly activity for all of us. So as we see anything, we’ll continue to drive the pricing up accordingly as we go forward.

Understood. Thank you.

Our next question comes from Nigel Coe with Wolfe Research. Please go ahead.

Thank you. Good morning. I wanted to circle back to orders. You called out two large orders. And I don’t recall – maybe, I’m wrong here, but I don’t really recall large orders swinging the number that much. So my question is, are we seeing here some evidence of increased product scope with E&I coming through on some of the orders here? And then maybe, just talk about E&I, how that’s been tracking? I mean, I understand it’s sort of in line with your FY 2020 plan so far, but margins, I think, are still tracking well below where the M&A plan was. I’m just wondering what the recovery plan looks like for E&I margins?

Nigel, I’ll take the first part of that. This is Rob. And then Gary, the second. As it relates to a couple of large orders, I think we’ve mentioned before, we – and I talked a little bit about the innovation. Some of our new innovations have really taken traction and people who hadn’t bought those solutions in the past or buying those. And then in some cases, securing more than a quarter’s worth of actual supply. We’re seeing 12 months supply being orders pace for that. So yes. So we kind of wanted to take those two orders out that were around some of the new products we’ve had to say, okay, our actual growth rate is around 12%. But that being said, we still very feel confident that there’s more price to go get. And normally, we don’t talk about, who the orders come in from and what, but we are beginning to see larger orders in the past. And then from the adoption of some of our new technologies that people haven’t used in the past and shift anyway from some of the traditional methodologies of, let’s say, thermal management. As regards to E&I, Gary?

Yes, absolutely, Rob. Hey, Nigel. Yes, we are pretty happy with the traction on the E&I side. So some of that incremental revenue that comes in, some of it flows through the E&I, as a little bit closer to the Vertiv, but it’s a lot of the solutions orientation that we’re getting by able to couple switch gear and busway into the broader solutions. We’re also being pretty effective, at this point, of ramping up the sales forces, particularly in that Tier 2 colo space in the enterprise space to sell additional bus lane switch gear. So all of that is in flight and on that side, probably tracking a little bit even faster than what we thought, being offset a little bit because it’s just tough to combine some of the cost synergies, clearly as fast as we thought with the supply chain and inflation piece of it. But if you take all of that and net it out, we’re pretty much right on plan. And if you look at no different than the core Vertiv Q4, if you look at the E&I Q4, they’ll be in the low 20s percent AOP type of run rate, which bodes really well to give us back on plan to where we should be for 2023. So all things considered, pretty happy with how the integration is going, the culture, the sales force, the customer responsiveness. The pricing, E&I got a late start on and we were very open about that even on the last call, but if you look at what they’ve done over the last couple of months, there’s good momentum there. So overall, really pretty pleased with the way that’s played out.

That’s great news. And then, my follow-on question is, maybe, you talk about the efforts around qualifying new suppliers and reengineering products. That was a big initiative, kind of towards the end of 2021. So just wondering if we’ve made much traction there and whether that’s having any discernible impact in terms of supply chain?

Sure. Nigel, this is Rob. Absolutely. And we continue to do that today. It’s not an effort that’s completed. Some of these redesigns are spins of new boards and the new code for different chips. Those take longer, right? Those don’t necessarily happen within a quarter. We see good progress on that. Some focused areas for us is some diversification in some of the breakers that we use. And we’ve been well through the qualifications of that, and that should help us as we go through this and continue to work really hard on the fan supply and looking at and qualifying and bringing on more suppliers there and different designs as well. So I feel good about that, and I feel like that – some of those after we get through released to manufacturing and the volumes can be hit by some of these new suppliers, yes, it could be a positive thing for at least towards the end of the year going into 2023. So I think what we’ve done, a lot of that will benefit from the latter part of this year, really kind of into next year as we move forward.

Okay. Great. Thanks Rob.

Thanks, Nigel.

Our next question comes from Lance Vitanza with Cowen. Please go ahead.

Hi guys. Congrats on the quarter. I have a two part question regarding price increases and Vertiv competitiveness versus its peers. It’s probably no surprise, but I’m hearing some anecdotes that some of your customers are none too pleased, and in some cases, have threatened to move business from Vertiv to other suppliers, the first chance they get. Now, I get it. No one likes to pay more and we all like to complain when we’re forced to pay more. So who knows what eventually happens. But my question is, a, do you worry that your price increases may ultimately leave you in a less competitive position versus your peers? And b, what, if anything, does this feedback suggest about your ability to maintain price when the supply chain eventually eases?

Hi, Lance this is Rob. Thanks for the question. I appreciate you joining today. What I would say as it relates to the competitiveness and the pricing. What we found something that we’ve learned really through all of this, which has been a good thing is, when we innovate, when we have a superior solution out there in the market, we can get price for that. And so as we think about our pricing, it isn’t just across the board price increases. And what we found is some of our leading innovative products that typically compete against, I would say, more small regional mom-and-pops is that people are willing to pay for that. They want a global supplier. So we feel good about that price sticking for the value we’re delivering. I would say, we probably underpriced on some of these innovative solutions with the value that they bring to our customers. And maybe, some frustration you’re hearing out there because we’re not seeing, we’re seeing in areas and finding areas where actually our prices were lower than they should be or lower than competitors. The market is frustrated in general about delivery and delivery timelines, because the growth that we’re seeing is unprecedented. So I would say, maybe, some of the noise, at least as I hear it is, hey, we want to get those products. We want to – it’s not an issue of the price, it’s an issue of delivery, and we need those products sooner rather than later. And so our thesis, now, has always been and will continue to be as an innovator and continue to provide more value to our customers. The market will pay for that. For example, some of the PUE stuff that we’re doing in our thermal units in China. We’re one of the few, if not only manufacturers now in China that can meet the government-mandated PUEs coming forward. So we will continue to differentiate on innovation and continue to drive price as it relates to that. There in areas that probably more commoditized, what we rely on there and it works is our service organization. People pay more for Vertiv products if they can get the Vertiv service behind that. So that’s another, I would call, a key differentiator for us that we’re seeing, that through these tough times, people want our service.

Thanks.

There are no further questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Rob Johnson for any closing remarks.

Thank you, Operator. While the macro environment remains volatile, I feel good about the actions we have taken to deliver on our commitments. I understand we are still in the process of earning back your trust. I believe our Q1 performance is a first step on that path. And I look forward to doing the same over the next several quarters. I want to express my appreciation to all of our employees, partners, customers and investors for their continued support, and I want to say thanks to everyone for being on the call today. This concludes our call.

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