Earnings Call Transcript
Vertiv Holdings Co (VRT)
Earnings Call Transcript - VRT Q2 2022
Operator, Operator
Good morning. My name is Nadia, and I'll be your conference operator today. At this time, I would like to welcome everyone to Vertiv's Second Quarter 2022 Earnings Conference Call. Please note that this call is being recorded.
Lynne Maxeiner, Vice President of Investor Relations
Great. Thank you, Nadia. Good morning and welcome to Vertiv's Second 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 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 today's earnings release, and you can learn more about these risks in our annual and quarterly reports 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 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.
Dave Cote, Executive Chairman
As I mentioned on our previous calls, we're taking 2022 a quarter at a time with an escalating performance profile as price increases are realized. It has taken time to work our way through the backlog, but as we do, performance escalates. The profile will look exactly the same as we outlined in February, but in substance, the story and performance are in line with that profile. End-market demand remains robust. Our order rates reflect this strength. And as market leaders in these spaces, we are furthering the gap by accelerating our new product introductions. We also continue addressing the operational areas, particularly in the Americas, that have caused shortfalls historically. While there are still some improvements to work through, the SIOP process in Americas under the leadership of Giordano Albertazzi is better aligned than ever. There is still work to do, but certainly, it is in a much better place and continuing to improve. There are other process improvements also being addressed by the new management team in the Americas. They are tackling challenging areas that have really become apparent during these recent periods of high volatility. The new management team is doing exactly what we need them to do: cleaning these issues up and resetting the base for a great runway ahead in the fourth quarter and 2023 in a very profitable part of the business, the Americas. The third quarter is expected to reflect a sequential step-up in performance followed by another anticipated large step upward for Q4. I know some of you may question our ability to deliver the second half as presented in our guidance, especially a significant fourth quarter. But the team will walk you through why and how we believe that will happen as price realization improves and supply improves with newly qualified suppliers. We remain on pace to achieve a significant step-up in financial performance that supports the earnings profile we presented in February. End markets remain strong, inflation is starting to moderate. We are navigating supply chain challenges and bringing additional suppliers online, and price is sticking. With the anticipated performance profile, we expect that 2023 can be a very good year for Vertiv and our shareholders. So with that, I'll turn the call over to Rob.
Rob Johnson, Chief Executive Officer
Thank you, Dave. Q2 was another step forward in delivering on our commitments for 2022. Starting with some of the key messages on Slide 3. Demand continues at a pace I've not seen in the 30 years of my career in this market. Orders were up 17% in the second quarter, 11% from volume and 10% from higher prices with a 4% deduction for foreign exchange. Our customers are focused on securing supply in a tight market, and we see that both in our orders and backlog, which firms up the demand outlook well into 2023. Our adjusted operating profit exceeded the midpoint of our guidance. We continue to work through a number of key actions for improvement. But where we have fully implemented change, we are seeing the benefits take hold. Key among them is our pricing performance. We have proved to ourselves and now, hopefully, to you, our investors, that we are a business that can get price. Our pricing plan remains at $360 million for the full year. Supply chain continues to be challenging, but we've made very good progress in securing qualified second and third sources of supply for key components, and we'll start seeing the benefits from that activity in Q3 and more fully in Q4. Our new thermal facility in Monterrey, Mexico has started production, and we have a new fan supplier coming online that is committed to help us meet the significant demand we are seeing across the thermal management market. Our work qualifying new suppliers is not only limited to fans. We have also qualified new breaker manufacturers, semiconductor suppliers, and other suppliers. While there's still more work to do, we have been aggressive in our actions to manage the challenging supply chain environment, most notably in the electronic components. In light of the supply chain conditions and in conjunction with the expected significant sales increase in the second half of the year, we have not been able to reduce inventory as quickly or as significantly as we anticipated and communicated earlier this year. While we're expected to use cash in the second quarter, it was larger than we anticipated. Although there should be an improvement in the next six months, we are reducing our full year expectations for free cash flow to a range of $25 million of use to $25 million of cash generation. As Dave mentioned, we made significant progress in our SIOP process globally, but we are especially happy with the progress we've made in the Americas and believe, based on these improved processes, inventory reduction should be a significant source of cash flow in 2023. While there are many moving pieces, we provided updated guidance for our adjusted operating profit, reducing the midpoint by $25 million. We have provided a detailed bridge on the changes in these slides on Slide 12 that David Fallon will cover shortly. There is some rebalancing between the third and fourth quarters. But in aggregate, we are still on pace to deliver a very strong second half with a noticeable step-up across key financial metrics. Turning to Slide 4. This slide summarizes what we see in the market by region. No change in our view across our end markets versus what we saw in April. They are still quite healthy and very strong. Cloud and colocation remain robust. You've seen this in the cloud growth rates reported by all major cloud providers. AWS reported last week that their cloud business increased 33% in the second quarter and believes that we are still in the early stages of enterprise and public sector cloud adoption. Certainly, the growth in the cloud market supports this view. Data growth is not slowing down. Our view on the enterprise and small to medium business remains consistent from Q1, and we believe edge applications will continue to provide growth and lift for these markets. The communication market continues to see 5G investment, and we're aligned with all the relevant players in this space. In the commercial and industrial market, vital applications continue to drive growth and opportunities for Vertiv. The market outlook remains very healthy. It is likely our year-over-year order growth rate will moderate in the second half as the comparisons to the prior year become more difficult. But I want to reiterate that the end markets we play in continue to be in very good shape. Moving on to Slide 5. Customer demand remains strong. Our order rate and backlog are a clear demonstration of this strength. We are delivering on our price plan and have implemented the necessary price actions to deliver the second half pricing plans, including that on our book-and-ship business. As I said earlier, the supply chain continues to be challenging, especially in electronics. We do not expect this to abate in 2022, and we anticipate that we will see pressure at least through the first half of 2023. We have incurred higher costs for electronic components since we had to go to the spot market to secure some of that supply. In addition, material and freight inflation was higher as absolute dollars for the second quarter, but generally in line with the adjusted for the higher volume. We have started to see some relief in commodity and freight markets. We typically see a benefit on this on a quarter lag, but it's expected to provide a nice tailwind for us as we go into 2023. We've made good progress in qualifying additional suppliers on key components and should start seeing additional supply reach our factories in late Q3 and further into Q4. This provides support to our volume assumptions for the ramp-up in Q3 and Q4. We had to add some fixed costs sooner than anticipated to support the volume lift in areas such as our new thermal plant in Monterrey, Mexico. In summary, the market remains strong. The supply chain is still complex, but we are getting to the implementation phase for the new suppliers that should help alleviate sourcing pressures on the most critical components. With that, I'll now turn it over to David to walk us through the financials. David?
David Fallon, Chief Financial Officer
Thanks, Rob. Turning to Page 6. This slide summarizes our second quarter financial results. As you can see, net sales increased 11% from last year's second quarter, and we're up 8% organically, including 2% from volume and 6% from price. The E&I acquisition added $114 million in net sales and was partially offset by a $60 million foreign exchange headwind, more than 70% of that headwind in EMEA. We also had a headwind related to the divestiture of our industrial UPS business in EMEA, which resulted in a $17 million headwind. Pricing added $80 million in the quarter, which was in line with guidance and double what we saw in the first quarter as we continue to burn through the lower-priced backlog and recognize more sales booked after we implemented substantial price increases late last year and earlier this year. Adjusted operating profit of $82 million exceeded the midpoint of guidance, but was $52 million lower than last year's second quarter. We list some of the components of this reduction at the bottom of the page. But in summary, there was $10 million unfavorable price/cost; and $45 million headwind from foreign exchange and other factors, including a $10 million foreign exchange headwind; $10 million from direct labor, inflation, and inefficiency, in part driven by supply chain challenges; and approximately $20 million from cost headwinds in the Americas, primarily related to customer support costs, our sales incentive compensation program, and several other drivers. We expect to see continued year-over-year cost headwinds in the Americas in the third quarter, but we believe we have identified and addressed most of these issues as we will enter the fourth quarter and transition into 2023. Adjusted diluted EPS was $0.10 for the quarter, which was in line with guidance. Second quarter free cash flow was negative $232 million. While we expected a net use of cash, it was certainly higher than we anticipated. As Rob mentioned, we have not reduced inventory consistent with our expectations at the beginning of the year, in part due to continued supply chain challenges, but also in preparation for the significant volume ramp in the second half of the year. We are improving our SIOP processes globally. And as Dave mentioned, notably in the Americas, we expect to receive an inventory free cash flow dividend at some point in 2023. Turning to Page 7. This slide summarizes our second quarter segment results. We saw a sequential quarterly improvement in organic sales growth, adjusted operating profit, and adjusted operating margin across all three regions. The Americas region grew organically 6.6% or $37 million, with most of that growth coming from price. We do anticipate more balance between price and volume in the Americas in the second half of 2022, including mid-teen year-over-year volume growth as we continue to qualify new suppliers and launch the Monterrey facility. Americas adjusted operating profit of $82 million was negatively impacted year-over-year by price/cost, higher fixed costs, including to support the volume ramp-up in the second half and additional cost headwinds we referenced on the previous slide. In APAC, organic sales increased 5.9% despite the China COVID lockdowns, which we estimate lowered second quarter sales by approximately $30 million. Notwithstanding the impact of the lockdowns, adjusted operating profit for APAC was actually higher than our expectations as we were able to drive higher sales in other APAC subregions while managing fixed costs. Finally, we continue to see strong growth in EMEA, with organic sales up 13.3% with a good balance between volume and price. While inflation accelerated in the second quarter from the first quarter, so did our pricing. Our second quarter net price/cost in EMEA, while still a headwind, was less of a headwind than what we saw in Q1, and we expect price/cost to be a significant tailwind in the second half of the year. Moving to Slide 8, we summarize our updated third quarter guidance, which is about $50 million lower at the midpoint than our previous guidance. This slide summarizes third quarter versus last year, but likely more relevant is an analysis of the changes from our previous guidance, which we will provide in a couple of slides. Despite the reduction, third quarter guidance still reflects a material sequential step-up from the second quarter across all of our key financial metrics with organic sales expected to be up approximately $100 million, 70% of that from volume, and adjusted operating profit expected to be up almost $60 million at the midpoint. Despite the reduction from our prior guidance, our third quarter expectations return us to an adjusted operating profit level from last year's third quarter and will serve as a strong bridge to a substantial improvement in the fourth quarter helping us transition into a very strong 2023. Next, turning to Page 9. This slide summarizes our revised full year financial guidance, which reflects the $37.5 million lower adjusted operating profit at the midpoint versus our prior guidance. Once again, we provide detail of this reduction on Slide 10, the next page. But from a macro perspective, it is driven by a $25 million foreign exchange headwind and an additional $12.5 million net from additional cost wins in various categories, partially offset by the benefit from incremental sales volume. And more on this on the next slide. As Rob mentioned at the outset, as it relates to free cash flow, we are reducing our full year guidance to a range of positive $25 to negative $25 million in part due to lower expected adjusted operating profit, but probably more significantly from changed expectations with our anticipated inventory reduction. We continue to improve our SIOP processes in what is a very challenging supply chain environment. We're encouraged that these improved processes will result in much-improved inventory management, but the timing of the inventory reduction benefits will likely be pushed into 2023. Nonetheless, we are still anticipating significant improvements in free cash flow in the second half of the year, notably in the fourth quarter. Now turning to Slide 10. We provide additional detail underlying changes from our previous guidance. As you can see on the slide, foreign currency translation, certainly driven by the strengthening U.S. dollar, negatively impacted net sales by approximately $160 million for the full year and adjusted operating profit by approximately $25 million. We have included some additional information on our foreign currency exposure on Page 27 in the appendix in this package. But just as a broad overview, over 50% of our sales are denominated in a currency other than the U.S. dollar. Changes in the euro and British pound have been more acute than other currencies. As a result, over 70% of our negative FX impact is in EMEA. Moving on, incremental volume is expected to generate an additional $230 million of sales, $100 million of that was in the second quarter, and these sales translate into $82 million of adjusted operating profit for the full year. There is a pronounced increase in volume in the fourth quarter as we have increased sales expectations, primarily in the Americas based on our success in qualifying new suppliers and the launch of the Monterrey facility. Material inflation is up $20 million from our previous guidance, $10 million in each Q2 and Q3, primarily driven by continued higher costs for electronic components and spot buys. We anticipate this pressure to ease somewhat heading into the fourth quarter as we continue to bring additional suppliers into our supply chain. We have reduced profit expectations for E&I for the full year by about $12 million. This is mostly driven by timing as shipments have shifted to the right into 2023. However, that business continues to improve, and the demand environment continues to be strong with backlog at E&I up over 60% from year-end 2021, which portends significant sales and profitability improvement heading into 2023. We have increased our fixed cost estimates for the year by approximately $30 million. Most of this is driven by timing as we anticipate adding some of these fixed costs in early 2023, but we accelerated the timing to support the higher volume in the second half and for early 2023. Some of these higher fixed costs are also related to IT spending as we continue to optimize our ERP system in the Americas. Lastly, other cost headwinds, primarily in the Americas, are associated with various underlying factors, most of which we believe are transitory and addressable and should be mitigated as we enter the fourth quarter and move into 2023. In summary, our current full year guidance is about $37 million lower than prior guidance at the midpoint, with $25 million of that related to FX, with $50 million of the $37 million reduction in the third quarter, offset by an $11 million increase in the fourth quarter and a $2 million beat in the second quarter. Next, turning to Slide 11. We provide a sequential bridge from the third quarter to the fourth quarter for both net sales and adjusted operating profit, highlighting a $220 million increase in net sales and a $113 million increase in adjusted operating profit. We understand that based on our fourth quarter last year, there may be some concerns with our ability to deliver a robust fourth quarter this year. To help allay these potential concerns, we provide this bridge, which quantifies the sources of the uplift. First, the higher volume is certainly supported by improved visibility in sourcing and, as we mentioned, the launch of the Monterrey facility. Additionally, it's important to note that we normally have a seasonal volume ramp from the third quarter to the fourth quarter. The $35 million sequential pricing benefit is driven by the continued burn of lower-priced backlog in previous quarters, with a majority of our fourth quarter shipments coming from higher-priced orders from late 2021 and early 2022. We anticipate approximately $10 million additional adjusted operating profit from E&I in the fourth quarter, primarily from incremental volume, which should flow through at higher margins pursuant to improved pricing, similar dynamics for the base Vertiv business. Finally, as we discussed on the prior slide, the other factors are driven by the ramp down in the Americas cost headwinds, partially offset by additional fixed costs. So in summary, the fourth quarter adjusted operating profit guidance of $253 million at the midpoint represents a substantial quarter for us, especially considering the $13 million adjusted operating profit in the first quarter and the $82 million in the second quarter. However, we believe we are addressing two of the most pressing issues that drove lower first half performance: pricing and supply chain constraints. We have visibility and confidence in our ability to deliver these fourth quarter projections. On the following slide, so Slides 12 through 14, we will continue to be transparent with our communications around our plan and provide additional details for the second half. In February, we laid out an aggressive but achievable plan through the first six months. Our high-level scorecard reflects $91 million higher sales, $25 million higher adjusted operating profit, $10 million higher pricing, and $5 million lower inflation. Likely more important, our expectations for the fourth quarter have not significantly changed from the beginning of the year. On Page 12, this illustrates our current quarterly sales guidance at the top of the slide compared to our prior April guidance at the bottom. There's certainly a lot of numbers on this slide, and I won't go through each one. But of note, on the right, is the increased volume growth from our previous guidance across all three regions, but most significantly in the Americas as we have referenced. Turning to Page 13. This slide summarizes our updated quarterly adjusted operating profit and margin guidance, a similar construct to the previous slide with current guidance at the top and the April guidance at the bottom. We've already discussed changes in guidance and the step-up from the third quarter to a fourth quarter that would represent a record high and by a wide margin for sales, adjusted operating profit, and adjusted operating margin between 14% and 15%. Finally for me, for prepared remarks on Slide 14, we show the expected quarterly 2022 progression of our regional adjusted operating margins. We have primarily focused externally on the recovery plan for the Americas. But as reflected on this slide, there is expected sequential quarterly adjusted operating margin improvement across all three regions. Even though not depicted on this slide, the same is true for E&I. The scale of the improvement is more significant in the Americas than in EMEA, as they were more impacted by inflation than APAC. But these charts illustrate that the entire Vertiv global team is driving improved execution. Clearly, we are focused on unlocking value on a global basis, and we know you are watching closely, and we'll continue to be very transparent about the status of our progress.
Rob Johnson, Chief Executive Officer
Thanks, David. Turning to Slide 15, where we provide our expectations for market conditions over the next 18 months or so, and share many of the drivers of optimism for 2023 that portends a very strong year. First, you've heard us comment several times on the strength of the market we serve. All major cloud companies are growing strongly and continue to invest. Colocation utilization rates continue to be high. Edge demand and 5G rollouts will continue, and we are very well positioned to win on both of those fronts. While we are certainly mindful of the possibilities of a recession, we don't believe that blunts the growth of data, certainly not in the near term or intermediate term. In fact, businesses could likely utilize more data in ways to enrich their business models and gain productivity across their operations in the face of recessionary conditions. In summary, our demand remains strong. We are currently filling our backlog for the second half of next year, and we expect these favorable conditions to continue. On the right-hand side of this slide, we provide a quick list of reasons to be optimistic about 2023. Our fourth quarter is shaping up consistent with our beginning-of-the-year expectations, with pricing actions returning profitability to where we were prior to the challenging supply chain and inflationary environment but at a higher level. In fact, we believe we are a much stronger company today, and we'll be a much stronger company tomorrow because of these events over the last 12 months and the results we are encouraged by that we see for 2023. Although we are not prepared to provide a lot of detail into 2023 expectations, we still need to execute and deliver in Q3 and Q4, and there's plenty of uncertainty with supply chain and inflation. To give everyone something to work with for next year, we directionally expect that our adjusted operating profit to be 50% higher in 2023 than in 2022. Of course, there are still a lot of moving pieces, and we will know more and will update this expectation after our third and fourth quarters. So please view this as a preliminary guidepost as we look forward to a strong 2023.
David Cote, Executive Chairman
On Slide 16, we summarize our key messages for today. Sitting here one quarter further into 2022, I feel more strongly than ever that the process improvements we've made and implemented throughout the year give us the ability and the consistency to get price, coupled with the corrective actions we've taken in the Americas, are going to result in a very successful future for Vertiv. Without a doubt, the proof will be in the back half of 2022. I pledge to you that we are committed to executing well and transparently communicating our progress. With that said, I want to thank our employees, our Board members for your continued support in our organization as we continue to make significant strides forward. I will now turn the call over to the operator, who will open up the lines for questions.
Operator, Operator
And our first question today comes from Nigel Coe of Wolfe Research.
Nigel Coe, Analyst
There's a lot to discuss here. I wanted to address the cost challenges you mentioned in Q2 that are affecting Q3 but expected to improve in Q4. Could you elaborate on that? You referred to some cost issues at the Monterrey facility in the Americas, so a quick overview of that would be appreciated.
David Fallon, Chief Financial Officer
Yes. Thanks, Nigel. This is David. So there's really two categories, and we try to break those out on Slide 10. The first category is related to fixed costs. These are certainly tied, although not completely tied, to additional costs to support the second half ramp-up in volume. Some of these costs we anticipated adding at the beginning of 2023, but we brought them forward. Most of these are plant-related costs, but they also include some engineering costs related to qualifying new vendors and parts. I think there's probably a question if these would create a tail or a headwind for 2023. I think that $15 million we're expecting in Q4, if you annualize that to $60 million versus the $30 million for this year, it would imply a $30 million headwind. Some of these costs are certainly one-time related to support either a hard ramp in a plant like Monterrey or a soft ramp in many of the other plants that are seeing high volumes, so I would not anticipate seeing a significant year-over-year headwind related to fixed costs in 2023. The other cost headwinds bucket, which we estimate at about $18 million in Q2 and $15 million in Q3, are transitory. These are very specific issues. We mentioned a couple of them in the slide deck: customer support costs, also higher costs related to the sales incentive plan. There are many other issues that Gio and his team have been identifying and addressing over the last two quarters. We believe we have them identified. They'll continue to present a headwind in Q3, but we believe these should be fully resolved in Q4 and, from a year-over-year basis, actually provide a nice year-over-year tailwind for 2023.
Nigel Coe, Analyst
I wanted to ask about the material inflation. It looks like there's a $10 million impact for both Q2 and Q3, but it remains neutral in Q4. Is this attributed to a more normalized purchasing pattern along with new suppliers for chips? Can you provide more details on this?
David Fallon, Chief Financial Officer
No. You're absolutely right. I think we've seen a little bit of stability, although there continues to be variability as it relates to electronic components. Inflation there is certainly higher than we anticipated heading into the quarter. The light at the end of the tunnel is related to the new supplier qualifications that we're seeing that should come online in the fourth quarter. So I think if you look at the ramp-up of new inflation, I think we saw $15 million in Q1. That ramped to $40 million in Q2, and we anticipate that $40 million of new inflation will remain consistent in Q3. We have implied in our guidance a $5 million dip in Q4, but that's still subject to change. There's still a lot of uncertainty and challenges with the electronic components. We're still relying to a certain extent on spot buys, but we believe we've taken proactive steps and initiatives to address those higher costs, primarily through qualifying new suppliers.
Nigel Coe, Analyst
My follow-on is the free cash flow in the second half of the year. You mentioned the SIOPs improving in 2023. Just wondering about the degree of confidence in executing on the second half free cash plan. And then perhaps more importantly, going into 2023, you mentioned an inventory free dividend in '23. Does that suggest that you're confident in converting over 100% in '23?
David Fallon, Chief Financial Officer
We are not ready to commit to a free cash flow conversion for next year, but we remain optimistic. Our initial guidance for inventory at the start of the year anticipated a $50 million reduction from the end of 2021, which was a significant increase from the end of 2020. In reality, we will likely increase inventory by about $100 million in 2022, resulting in a $150 million difference, along with other variables. This explains the decrease in our full-year projection from $150 million to around zero at the midpoint. There is certainly potential to optimize our inventory levels. We are confident in our execution towards that goal through our SIOP processes. I am hopeful that we will see a notable reduction in inventory, or at least from a Days Inventory Outstanding perspective, in 2023. We internally refer to this as a dividend, and we expect it to provide a meaningful one-time benefit from the inventory reduction in 2023, as well as ongoing advantages as we assess our performance.
Operator, Operator
And our next question comes from Scott Davis of Melius Research.
Scott Davis, Analyst
I wanted to talk a little bit about the Monterrey facility, if you will, because this is a new thing perhaps. But is the Monterrey facility replacing some higher-cost capacity in addition to creating new capacity? And can you just give us a little bit of color on why it's needed?
Rob Johnson, Chief Executive Officer
Yes. Scott, sure. We've seen a large uptick in our thermal business, especially with some of the innovative solutions that we've delivered. So it's really complementing. We're not shutting down any other capacity. It's really additional capacity for the additional volume that we're seeing. This is something we've been planning for a while, and we think Monterrey is a great place to be from a cost perspective. But it is really to help the ramp and the demand that we see and the backlog that we have in our thermal business.
Scott Davis, Analyst
Okay. Just to back up a little bit. The Vertiv story was always presented as maintaining steady fixed costs, which aligns with Dave Cote's strategy that you wrote about. However, it seems we've experienced several consecutive quarters without keeping fixed costs in check. Will we return to this approach in 2023? Where do you all stand on this?
David Fallon, Chief Financial Officer
Yes. Thanks, Scott. Oh, no. It's a great question. No. And Scott, I can assure you that's not the first time that question has been asked. It's certainly been a focus here internally. We are still absolutely committed to holding fixed costs constant on a year-over-year basis going forward. The added fixed costs that we're seeing here in 2022, that is more from a timing perspective. These are fixed costs that we had anticipated adding in the first half of 2023. Just to put these fixed costs in perspective, our second quarter sales at an annual run rate were about $5.6 billion. That's ramping up to $6.8 billion in the fourth quarter. We continue to focus on fixed costs. I think we have seen increases over the last couple of years, but most of those increases are pursuant to operations and higher capacity and also R&D. I can tell you, our administrative functions are absolutely constant from a fixed cost basis in 2023 versus 2022 versus 2021 and will continue to be. But we are selective with fixed costs. To the extent that it creates a future return, including R&D and from an operational perspective, we'll choose from a timing perspective to sometimes accelerate those.
Operator, Operator
And our next question comes from Jeffrey Sprague of Vertical Research.
Jeffrey Sprague, Analyst
I also wanted to discuss Monterrey and inquire about how crucial this capacity is for achieving the top line forecast for the year. Is the plant currently operational and delivering commercial products? Additionally, are we on a path that gives us confidence in generating the necessary revenues from that plant in the latter half of the year?
Rob Johnson, Chief Executive Officer
Yes. Jeff, this is Rob. Yes, Monterrey is, first of all, up and operating. It delivered even in Q2 some products to our customers. So we are shipping, and we are in the middle of a ramp with that going into Q3 and then a steeper ramp coming in Q4. As long as we get the supply, we feel confident with the way that plant is operating. It is needed to provide the necessary volume increase more so in Q4 for us. But we feel confident with the team. They've spent a lot of time down there. And so far so good with the product coming out of the plant right now.
Jeffrey Sprague, Analyst
Great. And also just on the cost side, what exactly is this customer support cost that you're talking about? Is this expedited freight? Is it allowances? What actually is going on there? And what's the visibility of that moderating?
David Fallon, Chief Financial Officer
Yes. Jeff, this is David. It's a combination of things. For example, we had to rent a crane to facilitate the installation of a product into a customer site. We continue to focus on our customers, and in some cases, we actually foot the bill as it relates to hitting timing. Some of those customer support costs are also pursuant to late deliveries. In some cases, our contracts include penalties if we don't deliver product in the agreed amount of time. A lot of these issues are tied into the supply chain. We're still kind of day to day as it relates to supply, which creates a lot of uncertainty with delivery. At some points, we just have to catch up and spend some of our own funds to hit some promised customer delivery dates. The reason this is tied into the new supply is that a lot of those pressures should go away as we continue to qualify new suppliers. When you can spread that risk over three or four vendors instead of one or two, it really helps plan out a plant and a delivery schedule, and we expect a significant amount of these costs to dissipate.
Jeffrey Sprague, Analyst
And sort of on that front, one last one for me and I'll pass it, just also kind of the internal operations of the company as it relates to systems and ERP. You mentioned still working on that. Maybe just an update on what needs to be accomplished and to what degree, if any. Is it still somewhat of a restraint on orders, delivery, operations, what have you?
David Fallon, Chief Financial Officer
Yes. I would say we are over the significant launch hurdle that you get with a lot of ERPs. That certainly created noise in the fourth quarter and early first quarter. We have a fully functioning system. It's not perfect, not many ERPs are a year after launch. In conjunction with some issues that we have identified in the Americas over the first six months, we're still identifying, we've actually seen the system as a very useful tool versus the system we previously had to address those issues. We continue to identify ways the system can help. I would say we have a fully functioning system, but we'll continue to invest in that system to optimize its usage and to address issues as they arise.
Operator, Operator
And our next question comes from Andy Kaplowitz of Citigroup.
Andrew Kaplowitz, Analyst
Could you talk about the progress you've made in getting the company more focused on pricing and why pricing hasn't gone up at least a little with volume and inflation, understanding that a lot of pricing was locked into backlog at the beginning of the year? You obviously are seeing significantly more volume than you previously expected. You did raise your inflation forecast a little bit. So why can't you get a little bit more price as revenue and inflation go up?
Rob Johnson, Chief Executive Officer
Yes, Andy, I'll address the first part regarding our pricing. We are pleased with the $360 million we've discussed for this year. Pricing has become an integral part of our strategy and processes on a global scale, and we continually assess it. Pricing is not a one-time action for us; we will keep evaluating it. We offer innovative solutions that ensure we receive the right price in the market. As we move through this year and into next, we do not anticipate responding to inflation in a reactive manner. Instead, we will refine our approach to driving price. Part of our strategy has involved creating exceptional products that address real customer needs and ensuring we are compensated for that. We will continue to pursue this as we advance.
David Fallon, Chief Financial Officer
Yes, thanks, Rob. And Andy, we anticipated that question. You're absolutely right. As volume assumptions increase, so should the pricing. We decided to maintain the pricing target at $360 million due to much of the additional volume being pushed to Q4, in order to keep things straightforward. It is important to recognize this as an opportunity for increased pricing based on that additional volume exceeding $360 million. We also have not accounted for potential inflation associated with that higher volume in our external model. Ultimately, it presents an opportunity, but we would also face offsets from potential additional pricing and inflation related to the increased volume. After considering this, we opted to keep our messaging simple from quarter to quarter. We have included this as a net opportunity in our assessment of risks and opportunities for the second half of the year.
Andrew Kaplowitz, Analyst
Sure. That's helpful. And then maybe if I could take that conversation into 2023, you obviously stated that you expect a 50% improvement in adjusted operating profit. Could you talk about, as we sit here today or maybe forecast forward, how much backlog coverage you have on that improvement? I think you said you expect supply chain and/or electronic component headwinds to last well into '23. So what kind of price versus cost or supply chain assumptions are you baking into that initial '23 expectation?
David Fallon, Chief Financial Officer
Yes, I can address that, Andy. We are not really prepared to provide extensive details at this point since it's still very early. As Rob mentioned on the call, we still need to deliver on Q3 and Q4. I would certainly include pricing as a potential opportunity for next year. We can observe this through the increased sequential pricing we've experienced each quarter in 2022. There will likely be a carryover pricing benefit of around $150 million to $200 million based on our calculations. Regarding backlog coverage, we have a solid backlog today, and we are partly filling that backlog for the second half of next year with some of our products. We feel optimistic about demand. However, we note that there is more uncertainty surrounding inflation and supply chain issues, which can fluctuate significantly from month to month and quarter to quarter. We believe we are taking proactive measures to address these challenges, but it’s difficult to provide any concrete expectations for next year at this time.
Operator, Operator
And our next question comes from Mark Delaney of Goldman Sachs.
Mark Delaney, Analyst
First question is on the implied 4Q outlook. Maybe you can better contextualize how much turns or book-and-ship business you're anticipating in that guide and how that compares to typical fourth quarters.
David Fallon, Chief Financial Officer
Yes. I would say we have really good visibility certainly into Q3. If you look at the backlog versus book-and-ship for Q4, it's likely higher than what we would see in other quarters, including for a fourth quarter. So a fairly significant ramp in Q4, at least from prior guidance, was not related to filling out a backlog. It was directly related to having the capacity and the supply of components to ship that backlog. Every quarter, and even in every month, there is a certain amount of book-and-ship business. I'd say we have robust confidence in our fourth quarter as it relates to backlog coverage. For us, as Rob mentioned, a bigger risk would be the execution of the ramp of the Monterrey facility and also the additional sand supply. Therefore, we don't see demand as an issue, certainly for Q3 or Q4.
Mark Delaney, Analyst
That's helpful. And my second question was on pricing, in particular, pricing for 2023. Maybe you can remind us how much of your negotiations are done toward the end of the calendar year for the following year. And kind of related to that, to the extent input costs stay where they are, do you think you'll be able to hold on to all the pricing you've been able to achieve as you go into 2023? Or will some of the customers say, 'Oh, with input costs going up, I’m looking for a reduction next year?'
Rob Johnson, Chief Executive Officer
Mark, this is Rob. Yes, the pricing actions have been implemented for what we needed to do. As I mentioned earlier, we continue to look for additional opportunities for pricing where we have innovative products and solutions. I feel confident that we've executed on those; they have been set in place for a while. As it relates to customers asking or looking to take the price down, it's kind of a similar phenomenon. We didn't gain much pricing on the backlog that we had. That was part of our problem. We had to burn through that, so we expect the same as we proceed; the hard purchase orders we currently have where people want the price we set forth in those will remain the same. I don't anticipate deterioration as we head into 2023 due to inflation conditions. We've bought inventory at higher prices, and our customers understand that. So it wouldn't be a major concern me that we're going to see that activity. We will continue, even in an environment where inflation wanes, to utilize our pricing skills to capture value when we provide additional value.
Operator, Operator
And our next question comes from Lance Vitanza of Cowen.
Lance Vitanza, Analyst
Congratulations on the strong quarter. I wanted to ask you about E&I. It looked a little bit weaker than expected and the guidance as well. You mentioned during the prepared remarks some timing-related issues. I think you said that the asset continues to improve, but maybe you could clarify if I'm getting that right. In any case, if you could elaborate a bit on exactly what the issues are there at E&I.
Rob Johnson, Chief Executive Officer
Yes, thank you for the question and your comments. Regarding E&I, we have noticed that some of their sales have shifted from this year to next year due to certain projects. E&I faced inflationary pressures and supply issues with breakers later than Vertiv, which delayed their ability to secure pricing. We believe this issue is now resolved, and we are optimistic. The backlog for E&I has increased by over 60% since our acquisition, and there is good activity with pricing included in both the backlog and incoming orders. I am more enthusiastic about the asset now than when we acquired it. While we did experience a dip and certain challenges, we anticipate E&I will rebound next year thanks to the additional pricing we've secured. We have seen some project delays in that sector since it is heavily tied to construction, and some of that work will extend into next year. Gary, do you have any other thoughts?
Gary Niederpruem, Chief Strategy and Development Officer
I think that’s exactly right, Rob. The amount of quote activity pipeline and the joint development between the Vertiv sellers and the E&I sellers, and the embracement that the customer base has had has been phenomenal. The only thing shifting, as Rob mentioned, are a few switchgears and some modular skidded power units that they sell which have moved to the right due to some supply and customer readiness issues. Overall, it’s coming up on point just like we planned earlier in the year.
Lance Vitanza, Analyst
So you're not seeing any issues with the integration or anything that would make you feel less excited about the acquisition?
Rob Johnson, Chief Executive Officer
No. Absolutely the opposite. I think integration has gone really well. A couple of stumbles we experienced were really focused on pricing and getting components. They were later on both of those. A lot of people are discussing breaker availability. Breakers drive a lot of the content in our products, which we still see as unavailable. We have looked at additional breaker sources and have been qualifying them. Overall, integration has gone well. I can tell you the synergy we thought we would derive from the acquisition is apparent. While we never included any sales synergy upside to our model, we see our sellers effectively reach out to a wider audience in the enterprise and to a broader base of customers that we touch. So I am happy with the asset, the management team there, and what they've done. I believe this will integrate smoothly with what we had predicted.
Operator, Operator
Our next question comes from Steve Tusa of JPMorgan.
C. Stephen Tusa, Analyst
So just on the backlog, I guess trying to read the tea leaves a little bit here with the big revenue ramp in the fourth quarter. Do you expect book-to-bill in the second half to be above 1 in total? Obviously, it will kind of modulate because of the big fourth quarter. But in total, do you think book-to-bill can be above 1?
David Fallon, Chief Financial Officer
Yes. We're still putting together our projections for orders for the fourth quarter. You can survey the second half sales number. I believe we would expect continued orders growth in Q3. Q4 presents a good year-over-year tailwind. However, I would say it's likely to be plus or minus close to that one-time book-to-bill.
C. Stephen Tusa, Analyst
Okay. And then just more philosophically, maybe a question for Dave. But how are we defining success at this stage? Is it a hard line on this fourth quarter and the 50% increase for 2023? Or if we continue to have these costs that pop up, like they have in the third quarter where guidance is below, and things keep getting pushed forward into '23, is that an acceptable outcome for you? Or is there a tighter hold now given what we've seen the last few quarters, acknowledging that sequential improvement is steady?
David Cote, Executive Chairman
Yes. I would say it's not so much the number itself for the fourth quarter as it is the lead into 2023. This whole year has been one of needing to transition through a backlog and prioritize more aggressive pricing than we previously exercised. Also, ensuring the Americas is fixed enough to perform well is key. That’s the game we are playing to ensure we transition into a very good 2023. The strategy of the company is still valid, still good. It’s a great position in a good industry. Technology remains impressive. We are still executing new product introductions and increasing R&D spending. The challenge has been to get the Americas fixed and ensure pricing is ahead of overall inflation trends. I feel good about how things are coming together this point.
C. Stephen Tusa, Analyst
And anything seasonally challenging about '23? If you do push anything out of Q4 into Q1, would you assume that price and cost dynamics wouldn't be that lumpy, so should you start '23 on a solid footing? If so, that reinforces what you see for '23?
David Cote, Executive Chairman
No. With the type of leads we should get from Q4, we would anticipate that 1Q will significantly differ from this year. Dave, I assume you agree with that.
David Fallon, Chief Financial Officer
I absolutely agree. The key is that we’re getting more fan supply in the fourth quarter that will certainly carry us into Q1 and Q2. While there is always seasonality, it should be far less pronounced next year.
Operator, Operator
Our next question comes from Andrew Obin of Bank of America.
David Ridley-Lane, Analyst
This is David Ridley-Lane on behalf of Andrew. Regarding hyperscale and colocation CapEx, although more secular than cyclical, traditionally, enterprise and SMB CapEx has been tied to the broader economy. I'm curious about what you're hearing from the sales teams regarding the enterprise pipeline. Have you heard anything about 2023 CapEx plans?
Rob Johnson, Chief Executive Officer
David, this is Rob. I'll address that. Gary, you can add in as well. What I would say is the activity in the enterprise has been cyclical due to COVID and the response because people are not fully going back to their offices. We are witnessing a phenomenon as people return that refreshes their edge IT infrastructure. So that activity remains fairly strong as we assess it. Projects in that space are still strong from our field perspectives.
Gary Niederpruem, Chief Strategy and Development Officer
I think that's exactly right, Rob. You're spot on. For the enterprise, there's not a light CapEx number published, so we focus on voice to customer and our own pipeline. We have not heard any conversations pick up around a scaling back. Everything we see in that area remains healthy. Though China had a slight setback due to COVID, their enterprise pipeline is now ramping up. Overall, everything appears robust.
Andrew Obin, Analyst
Got it. That's helpful. And then in the Americas region, which is critical for you to have a significant margin recovery, could you provide more details on internal initiatives beyond Monterrey that are driving margin expansion moving forward?
David Fallon, Chief Financial Officer
Yes. David, this is David. If you examine Q2 and some of the headwinds versus last year, price/cost played a role; the Americas was still negative price/cost in Q2, approximately $10 million. We believe that with the additional pricing we expect in the second half, we'll address that. Pricing will continue to be a lever. We clearly left money on the table. We could have priced more aggressively for a long while now. Given the robustness of our products, we'll be aggressive in pricing moving forward. We have identified many elements of operations that can be greatly improved. We discussed the SIOP process, which will not only improve inventory management but drive margins as well. Capacity planning, our organizational structure, and enhanced tools will benefit from ERP improvements. Over the last several years, the Americas was built with acquisitions that haven’t been fully integrated yet. While we have done extensive work on that, there are still many efficiencies yet to be unlocked. We're already starting to witness those improvements and expect an acceleration in 2023 and beyond.
Operator, Operator
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.
Rob Johnson, Chief Executive Officer
Okay. Thank you, and thank you to everyone for participating today and for your support. Our second quarter is another step forward in delivering on our plan that we detailed out last February. It continues to be a dynamic time in a challenging macro environment, but we remain firmly focused on executing a strong second half, which will provide a strong setup for 2023. Again, I appreciate everyone's support, and I'd like to thank everyone for joining the call today.
Operator, Operator
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.