Earnings Call Transcript - VRT Q3 2023

Operator, Operator

Good morning. My name is Bruno, and I'll be your conference operator for today. At this time, I would like to welcome everyone to Vertiv's Third Quarter 2023 Earnings Conference Call. Please note, 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. Please go ahead.

Lynne Maxeiner, Vice President of Investor Relations

Great. Thank you, and good morning, and welcome to Vertiv's First Quarter 2023 Earnings Conference Call. Joining me today are Vertiv's Executive Chairman, Dave Cote; Chief Executive Officer, David Fallon. Before we begin, I'd like to 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 made 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.

David Cote, Executive Chairman

Good morning, everyone. Well, we've delivered another strong quarter, built squarely on getting the fundamentals right, good operational execution throughout the organization that translated nicely, outperforming guidance in the third quarter. I believe we're starting to see a trend and one we plan to continue. Financial and operating performance continues to strengthen significantly across the board. And the most exciting part of that is we're still early in our path of improvement. Alignment to great end market matters. We have a great position in a good industry, and our technology differentiation continues to strengthen. Data continues to proliferate in good times and bad times. And that portends a very favorable end market environment for the foreseeable future. We're intending to finish the year strong. The benefits of our seed planning are taking hold and still to be fully realized. Our end markets remain resilient. Operational execution continues to improve, and there is still a lot of runway ahead. That is a great setup as we think about 2024 and beyond. So with that, I'll turn the call over to Gio.

Giordano Albertazzi, CEO

Well, thank you, Dave. Over the past year, we have greatly emphasized operational execution, focusing on improving margins and generating cash flow, all underpinned by a sense of urgency that fosters a high-performance culture. This quarter has shown positive results across the board, surpassing our own expectations and indicating that the business has more value to offer. Some key points include a 17% organic increase in third-quarter sales, with the Americas leading this growth at 40%. Although we are experiencing challenges in APAC, particularly in China, we are pleased to report an 11% increase in orders, excluding foreign exchange effects. While we were somewhat prepared for the strong order growth, the timing always carries uncertainty. The acceleration in order bookings suggests promising prospects ahead. Our adjusted operating profit stood at $296 million, with an adjusted operating margin of 17%. Our operational focus is yielding positive results and enhancing our margin performance. We achieved another strong cash flow quarter, a critical focus area for us, positively impacting our leverage, which was 2.4 at the end of September, with guidance projecting it close to 2x by the year-end. Given our performance thus far, we are raising our full-year guidance. We now expect sales for the full year to rise by 21% organically, an adjusted operating profit between $1,020 million and $1,030 million, and adjusted free cash flow around $625 million at the midpoint. It has been a robust year so far, and we anticipate this momentum to continue. Turning to the market environment, it remains consistent with our previous update from 90 days ago, with healthy overall markets. The data center sector remains strong, driven by growth in cloud hyperscale and colocation, with increasing demand evident in the near future. Different customers are at various stages in their demand cycles, but all acknowledge the impending strong demand. We are seeing a more optimistic outlook from enterprise customers, though it is tempered by some macroeconomic concerns. The telecom sector remains weak, as some telecom carriers have postponed investments, leading to a lull following several years of significant 5G investment. Regionally, APAC is still soft, mainly due to a sluggish market in China, though there are some positive developments in India and other parts of Asia. We do not foresee a sharp recovery in China, expecting it to remain subdued until late 2024. However, India is showing significant promise, with considerable investment and a trend likely to last. Activity in Malaysia, the Philippines, and Southeast Asia is also encouraging. I remain optimistic about market indicators, as we witness demand forming in our pipeline and order book from customers globally. Moving on to orders in Q3, they were up 11% year-on-year and 16% sequentially. As I have mentioned throughout the year, our pipeline activity is strong, and it is translating into orders, which is promising. We expect Q4 orders to also show positive year-on-year growth, potentially mirroring Q3's performance as velocity increases. We often receive questions regarding AI activity in our order book, framed as binary inquiries. However, the reality is more nuanced. For technologies applied unequivocally to high-density GPU or compute, such as liquid cooling and power distribution solutions, our order book reflects tens of millions of dollars. Yet, many of our products, including chillers and cooling systems, support various compute types, including AI. The overall volume related to AI or future-proof data centers far exceeds that initial figure. Many data centers are designed to be multi-purpose, meaning most of our offerings can support different types of compute, including AI. This comprehensive portfolio across all critical infrastructure technologies positions us uniquely compared to others. Various players ranging from hyperscale and colocation to enterprise and edge will approach AI differently, which aligns well with our capabilities. Complexity and customization at scale are our strengths. Therefore, while AI is emerging, we expect its impact to be more noticeable in 2024. Regarding the supply chain, we are in a significantly improved position compared to prior years. Our lead times have noticeably decreased as key component suppliers have made substantial capacity investments, which we are benefiting from. We have qualified many additional suppliers while focusing on geopolitical diversification and overall supply chain resilience. We are securing capacity in key areas to ensure our supply base can accommodate today's needs and future growth scenarios. Moving to capacity, we have a strong foundation with 22 manufacturing plants worldwide, enabling us to scale effectively. Our facilities have been designed with future growth in mind, and we are actively expanding and ramping up new facilities. We currently have around 25% additional buffer capacity in our plants to support intense growth periods and can optimize production across facilities. We continue to invest in productivity as a means to enhance capacity. Our operating system is being vigorously deployed to unlock further capacity. Having run a plant in my early years, I hold manufacturing close to my heart. We will keep making capital investments to support growth, doing so in a careful manner that does not significantly alter our cash flow profile. We can invest in growth wisely while still generating strong free cash flow.

David Fallon, CEO

Great. Thanks, Gio. Turning in the presentation to Page 7. This slide summarizes our third quarter financial results. As you can see, strong financial performance continues across the board. Organic net sales up 17%, with 9% from volume and 8% from pricing. As Gio mentioned, we continue to see the Americas, which was up 40% organically, drive the growth engine, particularly in this past third quarter. Adjusted operating profit was $162 million higher than last year's third quarter, mainly driven by a $100 million price cost benefit and $45 million of volume. Adjusted operating profit was over $40 million higher than our prior guidance, driven by $15 million higher-than-anticipated pricing and $30 million lower inflation, as we have seen some core metals, notably steel, trending lower in the past quarter. We did have a one-time $7 million benefit from a commercial concession as we note on this slide that also contributed to the favorability versus prior guidance. This commercial concession also positively influenced adjusted operating margin by 40 to 50 basis points as adjusted operating margin reached 17% in the quarter. That is 790 basis points higher than last year, a great indicator of the significant progress we have made in a relatively short period in driving operational execution. Certainly more work to do, but third quarter results should provide some confidence in our ability to achieve our longer-term margin targets. Moving to the right on this slide. We had another strong quarter of adjusted free cash flow, generating $221 million in the quarter, a year-over-year improvement of $241 million. We continue to see the benefit of higher profitability and improved working capital management across the organization. Cash taxes were higher, the inevitable result of driving higher profitability. But in general, we are driving much more consistency and predictability with our cash flow, controlling the things that matter, notably trade working capital, as we fully appreciate that sales and profitability mean little if they do not translate into cash flow, which is absolutely essential to drive long-term shareholder value. Last on this slide, if you look at the bottom right-hand corner, net leverage declined to 2.4x at the end of the quarter and is expected to be approximately 2.1x by year-end. Of course, this net leverage improvement certainly correlates with improved cash generation. Clearly, our balance sheet continues to strengthen, which provides flexibility as we think about capital deployment. More to come on capital deployment in our November 29th Investor Conference. Next, turning to Page 8. This slide summarizes our third quarter segment results. The Americas region continues its strong growth trajectory with organic net sales up 40%, including 28% from volume and 12% from pricing. We continue to see substantial year-over-year improvement in adjusted operating margin in the Americas, up 910 basis points, which is largely driven by favorable price cost and fixed cost leverage. APAC top line, moving to the center section of the graph, continues to be negatively impacted by China, with organic net sales in that region declining 7% from last year. From a subregion perspective, the rest of Asia, so everything outside of China continues to grow nicely year-over-year, up low double digits in the third quarter. Adjusted operating margin for APAC remained flat year-over-year despite the lower sales at 19.1%, really a strong testament to their focus on cost control while continuing to drive margin enhancements. Now we do anticipate that APAC will return to mid- to low single-digit year-over-year growth in the fourth quarter, in part due to typical fourth quarter seasonality in China, but this region will likely be down for the full year 2023 versus 2022. And we are not planning for a sharp recovery in China at the beginning of 2024. Rather, we are expecting sales activity to be relatively muted, at least until the back half of next year. The EMEA region was relatively flat organically in the third quarter, which was slightly better than we anticipated in guidance. Flat year-over-year sales in the quarter was mostly due to timing, as we expect a significant sequential increase in the fourth quarter, with full year organic sales growth in that region in the upper single to low double digits. EMEA continues to deliver strong adjusted operating margin, almost 28% this quarter, an increase of 1,030 basis points compared with last year's third quarter, with the improvement driven by favorable price/cost and good fixed cost control. Finally, corporate costs in the third quarter were approximately $7 million higher than last year, driven by both R&D investment and an incremental $3 million foreign exchange loss. Our current guidance assumes second half corporate costs in the aggregate to be consistent with the first half. Next, turning to Page 9. This slide summarizes our fourth quarter guidance. We expect a strong finish to the year with adjusted operating profit in the range of $295 million to $305 million and adjusted operating margin at 16.3% at the midpoint, 360 basis points higher than last year's fourth quarter. Adjusted operating margin is expected to be down sequentially from the 17% in the third quarter as regional mix plays a role with higher APAC volume. And recall that the third quarter was favorably impacted by the commercial concession that we talked about a couple of slides ago. Adjusted free cash flow is also projected to be lower sequentially as we expect CapEx to ramp up about $35 million, a lot of that driven by timing. And working capital use should be approximately $35 million higher in the fourth quarter versus the third quarter as sales are expected to increase about $100 million sequentially. China cash collections are a watch item for the fourth quarter, with larger customers paying a bit slower given the macro environment there and the impact on cash availability. Next, moving to Slide 10, our full year guidance. We are increasing projected full year sales by approximately $30 million and adjusted operating profit to $1.20 billion to $1.30 billion, an increase of over $580 million from 2022. This revised guidance is approximately $75 million higher than previous guidance, with $40 million from the third quarter beat and $35 million from the raise in the fourth quarter. Full year adjusted operating margin is expected to be 15%, 730 basis points higher than last year, with approximately 500 basis points from higher variable contribution margin and over 200 basis points from fixed cost leverage. Finally, we are increasing adjusted free cash flow guidance by $75 million to $625 million at the midpoint, $885 million higher than last year. This improvement demonstrates our focus on cash and the operational process improvements that have taken hold across the organization. Our commitment to delivering strong and consistent free cash flow is a crucial part of our high-performance culture, and I believe this could be a harbinger of continued good things to come. And with that said, I turn it back over to Gio.

Giordano Albertazzi, CEO

Well, thank you, David. Thanks a lot. And let's go to Slide 11. So some initial thoughts on 2024. I'm going to say we see more tailwinds than headwinds. Our starting point is strong. The data center market continues to accelerate. And AI is forming a tailwind that will likely be more evident in 2024. Our supply chain resilience is at a much greater level of maturity. This is important as we think about the demand profiles that may emerge for next year and beyond. Balanced investments in the business will continue. R&D capacity and things that will support the growth of the business for the years to come. We will continue our relentless focus on operational execution and implement the Vertiv operating system increasingly deeply. This will support continuous improvement consistently. We have started making progress, but much more to come. There are headwinds too. Certainly, China is slow, and recovery doesn't appear near term. Worth noting, we anticipate more normal seasonality returning in 2024. For Vertiv, that typically means our financial measures in absolute dollars get stronger sequentially as the year progresses. Let's go to Slide 12. Once more, remind everyone that we have our first Investor Conference on the 29th of November. So here are the topics we plan to cover that day. We will be sharing a lot of exciting information. I look forward to spending the day with you, talking about our strategy, technology, market conditions, operations, and financial framework. We hope you will be able to join us, preferably in person or remote. Let's go to Slide 13. I'd say we have meaningfully evolved from where we were a year ago. You can see that across all the key takeaways on this slide. A lot of improvement. It has been quite intense and fun, and we are still quite far from our full potential. I want to thank our team around the world for the passion and the hard work, tackling challenges every day, making sure we exceed our customer expectations, helping the entire industry scale and holding ourselves accountable for delivering strong results every quarter. I am sure you can see the early signs of a high-performing culture. With that, over to the operator. Over to you, Bruno.

Operator, Operator

Thank you. Our first question comes from Scott Davis from Melius Research.

Scott Davis, Analyst

I'm looking at Slide 11, how does telecom fit into this situation? Is its absence a neutral factor? I'm not sure, I'll just leave it at that.

Giordano Albertazzi, CEO

Yes. No, Scott. I would say, telecom is neutral right now in this whole picture. Honestly speaking, the fact that telecom is soft is no new news this quarter. That's something that we already signaled for at least the last two calls. So we see that continuing in 2024. If anything, we can be surprised by the opposite. In the industry, there are some expectations that sooner or later, the extreme edge will happen in the telecom perimeter operations, but again, not counting on that but having the right technology available and the customer reach if that happens.

Scott Davis, Analyst

Okay. That's helpful. And just as a quick follow-up, price. This has been an industry historically where price wasn't really a big deal until you had the supply chain debacle and needed to get after some. But do you have to start giving back some of that when you get into 2024? Is there a new paradigm just because your value-based selling and figuring out how to hold the line on price a little bit more effectively than maybe in the past?

Giordano Albertazzi, CEO

Yes, Scott. Certainly, value is a big element. The industry and the line technology is becoming more complex. We will talk certainly about high density. We'll talk about the overall net increment on installed power and the need for total cost of ownership, efficiency, etc. So the world is becoming more complex. Value in terms of the technology that you deliver matters. And we talked about Vertiv's ability to exercise the pricing muscle, both in terms of process and in terms of translating value in the initial price, both in terms of project pricing process and in general, pricing new technology. But it's also true that in the industry, there is more demand than capacity. So that is certainly a favorable environment in many respects. I'm going to say that we see in the future diminishing price gains. We have certainly enjoyed a lot of the kind of catching up after the inflation. But again, we continue to be positive about the future from an investor perspective.

Scott Davis, Analyst

Sounds encouraging. We'll see you all at the Analyst Day. Thank you.

Giordano Albertazzi, CEO

Looking forward.

Operator, Operator

Our next question comes from Nicole DeBlase from Deutsche Bank.

Nicole DeBlase, Analyst

Maybe we could just start with the comments that you guys made about 2024. I think it's an important distinction with one half versus two halves since the comps are really difficult in the first half. And I guess the follow-up to that comment is, do you still expect to be able to grow organically in the first half of the year? Or is that going to be totally back half weighted just because of the comp dynamic?

Giordano Albertazzi, CEO

Nicole, as I mentioned, let me elaborate on it. As I mentioned, we are going more towards a normal is what is historically normal first half, second half. 2023 may expect a little bit abnormal in the sense that we had a pent-up backlog, let me say, almost a 2022 backlog residue that we moved because of the shortage of components, etc. So that makes certainly a more flat H1, H2 year. In this moment, we are thinking something that probably will be around 45%, 55% top line, first half, second half. Give and take something, it's too early to say, but that's probably the thought process. I would be surprised, and it's again, early, but I would be surprised if H1 '24 were below 2023. So I think it was going to be positive all the way through. But again, we'd like to be clear about the seasonality. That's all.

Nicole DeBlase, Analyst

That's really helpful. And then the comments that you guys made about capacity and investing in the business. I guess, if we kind of look at the multiyear CapEx picture, are you trying to send the message that CapEx does need to grow from current levels? Or do you think that you can kind of expand capacity gradually at the current levels of spend?

Giordano Albertazzi, CEO

There will be some growth in capital expenditures, especially as our revenue increases. There will be a proportional relationship, but likely a bit stronger than that. I believe this reflects a unique trend in the primary industry we serve. As we mentioned, we have various strategies to ensure we can provide the needed capacity. One approach is enhancing productivity by fully utilizing the capacity we've developed over the past few years. If market conditions align as we anticipate, we plan to adopt a somewhat more aggressive stance. However, I want to emphasize that we do not expect this to significantly change the overall cash flow profile of the business.

Operator, Operator

Our next question comes from Amit Daryanani from Evercore.

Amit Daryanani, Analyst

Congratulations on a strong set of results. My first question is about your orders, which showed an impressive acceleration with an 11% year-over-year increase. You seem more optimistic about the future as well. Can you explain how much of this growth in orders is due to increased volume compared to price changes? Additionally, are you seeing any trends in the duration of customer orders? It would be great if you could elaborate on the interplay between pricing, volume, and order duration.

Giordano Albertazzi, CEO

There is a significant volume in the orders we've taken, and we are seeing strong price numbers this year in our sales, though we expect that to moderate somewhat. Future growth will have a robust volume component. Regarding the duration of the orders we're receiving, it's a mixed situation. On one side, we have shorter lead times that positively impact our run rate and are beneficial for creating an installed base for future service revenue. On the other side, we observe that larger players, including hyperscalers and major colocation providers, are looking further out in terms of order coverage. Overall, it's a favorable combination of both aspects.

Amit Daryanani, Analyst

Got it. That is really helpful. And then if I can get your perspective on this. There's an expectation that new data center deployments will add, I don't know, 15, 20 gigawatts of incremental power consumption in the next few years. And you think about these racks going from 10 kilowatts to 50, 100. Can you talk about what this does to your power management side of the portfolio? Do we need a completely different set of power solutions versus what we have today? What does that imply for power management, because I think your focus is on the cooling side, which is obviously incredibly positive. But I'd love to know how does it play out on the power management side as we shift into these higher density racks?

Giordano Albertazzi, CEO

It's an important point that this is a crucial aspect of our portfolio, both in terms of thermal management and the benefits from the expansion and increased capacity you mentioned. Overall, our powertrain, which includes everything from medium voltage switchgear to busbars and PDUs, will not change significantly. It will simply see more deployment due to the increased power needed to transfer from the grid to the chip. This is positive news, as it indicates a net increase in volume. There will be some adjustments in power distribution within the racks, with some PDU solutions designed for higher density, but this will only account for a small part of the overall powertrain that will expand. Another positive aspect for our power business is the ongoing constraint of power availability for new data centers. This situation is prompting operators to explore alternative power solutions. We are actively investigating dynamic power solutions, microgrids, and battery energy storage systems, which represent promising future opportunities. We are collaborating with major players in these areas for proof of concepts, making it a significant opportunity for us moving forward.

Operator, Operator

Our next question comes from Nigel Coe from Wolfe Research.

Nigel Coe, Analyst

Thank you for the insights on Investor Day. I would like to get more details on the geographic performance. EMEA had some setbacks this quarter, as you mentioned with the project delays. However, it seems to have recovered well in the fourth quarter. What is your outlook for 2024 regarding this region? Where do you identify strengths or weaknesses in Europe, particularly in light of the macroeconomic conditions? Additionally, you've indicated that you do not expect a recovery in China until late 2024. Is there sufficient growth in markets like India and the Philippines to compensate for that in 2024?

Giordano Albertazzi, CEO

I think it's a bit early to provide specifics about geographics in APAC. However, we are very optimistic about the developments in India and Southeast Asia. We continue to be a strong local player in China, but we are approaching next year with caution. In terms of EMEA, I am pleased with the pipeline and the conversations we've had with various customers. While the macroeconomic situation in EMEA isn't great and the geopolitical climate is challenging, our position and pipelines in EMEA remain strong. Although the Middle East presents uncertainty and isn't a large part of our market or revenue, we are confident in what we can manage in EMEA.

Nigel Coe, Analyst

Great. A quick one on pricing, because I think it's important to sort of like bet this, because there are some concerns around price rollback. Are you seeing any price sensitivity or price-based negotiations or price-based competition across your businesses in any meaningful extent? And then maybe, David, if you could opine perhaps on the carry forward from 4Q pricing into 2024. We calculate about 2 points-plus of price carry forwards. Is that in the right zone?

Giordano Albertazzi, CEO

So Nigel, I'll start with a general comment about the market. I mean, we will live in a commercially active world. Don't get me wrong. Different geographies, especially different types of market, have slightly different dynamics from a price standpoint. But overall, we are optimistic about our ability to continue to have a commercial advantage.

David Fallon, CEO

Yes. And Nigel, on your question on pricing carryover, unfortunately, it's probably a little premature to give specific numbers, but there certainly will be some benefit. It probably is not reasonable to anticipate 8% pricing every year going forward like we've seen this year and even the 7% last year. However, we do anticipate to have some carryover impact. The one thing we can safely say, it's certainly our intention going forward, even beyond, to be price/cost positive.

Operator, Operator

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

Andrew Obin, Analyst

So as you look at your AI-related pipeline, are we building more for new build locations? Or is it more retrofit of existing data centers? What does it look like from your perspective?

Giordano Albertazzi, CEO

Retrofit will be an opportunity, definitely. In this moment, we predominantly but not exclusively see new builds. But there is also quite encouraging conversations about retrofit. Things are very much in flux; we participate in both conversations very actively.

Andrew Obin, Analyst

And just a follow-up. Where are you currently regarding U.S. capacity utilization? How much additional U.S. capacity is expected to be in place by the end of 2024? What are your current plans? Additionally, how flexible can you be in moving capacity from other regions to the U.S., considering the different electrical standards?

Giordano Albertazzi, CEO

Yes, I definitely agree. The general increase of 25% that we mentioned earlier applies broadly around the world. This is particularly accurate for the North American business right now. We will continue to invest, and we have a clear initiative to utilize global capacity for the U.S. We are already implementing this to varying degrees across different lines of business, and we will enhance our efforts in this area moving forward. Concerning American codes versus other types of codes, it mainly depends on obtaining the right certification for plants outside of North America. We are working on this, depending on the technology, and it is very focused on margins, which is something we will continue to prioritize as we advance.

Operator, Operator

Our next question comes from Andy Kaplowitz from Citigroup.

Andy Kaplowitz, Analyst

I know you said that the positive order inflection you're seeing hasn't really been that unexpected. But can you talk about how you're thinking about the longevity of the current order inflection? Would you expect order growth to continue to accelerate into '24? And then how are you thinking about the duration of the upcycle? Do you see the AI contribution as sort of a big gold rush and then it flames out? Or could it last quite a long time?

Giordano Albertazzi, CEO

The last part of your question, we believe this is a long-term trend. In a sense that we believe that AI will be pretty pervasive. This is just the beginning. This is a multiyear cycle, we believe.

Andy Kaplowitz, Analyst

And Gio, maybe just in thinking about the mix of orders, you mentioned enterprise markets. Maybe some encouraging trends there. How much of the incremental order growth is from hyperscale and colo customers? Are they now a larger percentage of your orders versus enterprise? And then how would you characterize the enterprise market? You mentioned some positive signs, but obviously, rates are higher and concerns around the economy. So color would be helpful.

Giordano Albertazzi, CEO

Yes, definitely, colocation and hyperscale are a very large part of our mix and our order intake, growing actually in terms of speed of growth. So well covered there. What we see is that the acceleration in compute power and anyway, utilization, and volume of data that is further accentuated by AI is going to require some infrastructure also on the enterprise side of the equation. More distributed compute, more edge compute or sometimes even on-prem or proprietary data centers. So clearly, the biggest part of the acceleration is coming, and it will come from the hyperscale, colo and cloud. But we are optimistic and positive about the enterprise business. Plus, the enterprise business constitutes a big portion of what I was referring to, our more distributed territory go-to-market and type of segment. We are helped by improving lead times. We are accelerating that part of the market.

Operator, Operator

Our next question comes from Mark Delaney from Goldman Sachs.

Mark Delaney, Analyst

Yes. Congratulations on the good results. Hoping you could elaborate a bit more on what you're seeing in China and some of the causes of the weakness. In a related topic, to what extent do you think geopolitics and export restrictions for AI could impact Vertiv in China, even if it's an indirect effect, Vertiv's own products aren't directly subject to any sort of export controls?

Giordano Albertazzi, CEO

Yes. Well, we see China as really a general market situation, more so than anything to do with the export restrictions in our case. I just want to remind everyone that no data flows through our systems. The only thing we power and cool is IT infrastructure. So clearly, the market is not strong in China right now. We participate in the market as a very local supplier, a very local player. The majority of our supply chain is local. So we operate as a Chinese supplier, and we move with that market. And that market in this moment is not strong.

Mark Delaney, Analyst

That's helpful, Gio. And my other question is just around pricing and came in better than your guidance in the third quarter. There's no larger tailwinds in terms of pricing in the 2023 guidance relative to what you assumed last quarter. Can you just talk a little bit more on what's been driving the pricing strength that you're seeing in 3Q and for the year? And to what extent it's more about mix or like-for-like pricing?

Giordano Albertazzi, CEO

Well, again, there are a number of actions that we have implemented from a pricing standpoint. But clearly, the mix, the sequence of orders that we execute and a certain degree of being on the safe side in guiding have all contributed to this price/cost upside.

Mark Delaney, Analyst

Got it. Congrats again on the good results.

Operator, Operator

Our next question comes from Steve Tusa from JPMorgan.

Steve Tusa, Analyst

I wanted to explore the comments regarding the first half of next year further. We've been hearing that there are some early signs of orders for next year from hyperscalers, along with some significant orders in the past couple of weeks. The main concern seems to be when they will actually want delivery and when suppliers will be ready to produce. I'm interested in whether you're observing this pattern and if your caution about next year is mostly due to uncertainty around shipping timelines, considering we are in a dynamic growth environment where these clients are still figuring out the best approach. I'm looking for insight into how solid that demand is early in October. It seems logical that you're discussing capacity and demonstrating that you have it, which contrasts with what many perceive as a slow start to next year. I'm trying to piece this together and understand how clear your visibility on orders is early in the fourth quarter.

Giordano Albertazzi, CEO

No, just when we're sharing the slides, we expect a fourth quarter that is going to be up more or less the same that we think something around what we experienced in Q3. So we're quite optimistic about that. I would say that we should not read too much into the first half, second half; that's the normal nature of the industry. And again, it would have been the same in 2023 first half, were it not for the supply constraints that marred the entire 2022 for us and for everyone else. If anything, there was an artificial drift of backlog from the second half of 2022 to the first half of 2023, which balanced the two halves in 2023 in a way that is not so normal in our type of business. So I would not read too much into it. We are happy about our pipeline. We're happy about the order pace. Yes, a lot of those orders will be coming from hyperscale and colo and that type of market, and really, those orders are placed today for tomorrow. Those are aligned with the big site deployments, with fairly forward-looking project plans. I look at it as something quite normal, starting to happen again.

Steve Tusa, Analyst

That makes sense. Do you have any updates on the progress of the liquid cooling strategy? I expect we'll hear more about it on the 29th, but any details on how you are approaching that solution?

Giordano Albertazzi, CEO

Well, we are very happy by the way things are progressing in terms of portfolio, in terms of partnerships, etc. We see this piece as additive because it adds a link to the cooling chain, so to speak, to the thermal chain. We will certainly have more details at Investor Day here, but I feel pretty good about what we're doing also with our partners and the biggest chip manufacturers.

Operator, Operator

Our next question comes from Jeff Sprague from Vertical Research.

Jeffrey Sprague, Analyst

And just a couple for me. I wonder if we could talk about service a little bit. Obviously, it isn't growing anywhere near the rate of equipment, which I think is tied to the mix of where the equipment is going. But all this talk about system integration complexity and the like, what is the prospect for kind of service growth to accelerate here or service revenue per unit or per megawatt deployed, however you might frame it? Maybe you could give us some perspective there.

Giordano Albertazzi, CEO

Yes. Service is accelerating for us towards a double-digit growth territory, which, of course, we like. It is in the nature of service, especially the life cycle part of service. I always like to think in terms of project services, the services that you sell with new equipment, and instead the life cycle, the duration of the life of the kit. The latter is very important from a profit standpoint, from a customer experience standpoint, but also very important because it compounds over time. But it's built on the installed base that we are growing. So we are happy about the direction. We want to accelerate further, and we'll accelerate further. But definitely, a component of service that is being able and uniquely given our global footprint and experience, uniquely able to accompany our customers in the complexity from an installation commissioning start-up standpoint or retrofit standpoint, customer on the journey of high density, be it cooling or power high density is something that we are well-equipped for and getting ready for. I'm really excited about our service opportunity going forward.

Jeffrey Sprague, Analyst

Then maybe you could address capital deployment a little bit more, and maybe we'll hear more about that next month. But maybe your appetite for M&A, your view on whether the organization is up to digesting something else, or share repurchases in the cards? Maybe just what the priorities might be?

Giordano Albertazzi, CEO

I would say that there's certainly a very relevant question. Our Investor Day is relatively soon, about a month. The best thing is to just ask you to be patient with us for another month, and we will certainly go into those details together on the 29th of November. Bear with us for now.

Operator, Operator

Our next question comes from Lance Vitanza from TD Cowen.

Lance Vitanza, Analyst

My question is around how Vertiv is positioned specifically with respect to liquid cooling and direct-to-chip technologies. Are there notable gaps in your product portfolio? And if so, how do you expect to address them?

Giordano Albertazzi, CEO

Hey, Lance, we feel very good about our liquid cooling portfolio. It's a broad portfolio that stretches direct-to-chip, immersion cooling, so we feel good with what we have today in the portfolio.

Lance Vitanza, Analyst

My follow-up was just to ask if you are concerned about the possibility of being bypassed by hyperscalers or chip manufacturers who might integrate their own or another's technology directly into the chip or rack, thus avoiding Vertiv. Is that a concern for you?

Giordano Albertazzi, CEO

We are working very closely with both hyperscalers and chip manufacturers. The whole landscape of high-density cooling and power looks very promising to us. We will have more discussions at the Investor Day as well.

Operator, Operator

We currently have no further questions. So I would like to hand over back to Giordano for closing remarks.

Giordano Albertazzi, CEO

All right. Thank you very much. So again, 2023 is certainly shaping up as a strong year. We're happy about that. Again, an opportunity for me to thank the Vertiv team around the world for their hard work, dedication, and focus. We have definitely seen the benefits of stronger execution. We really appreciate your support. We look forward to connecting with all of you in November at our Investor Conference. With that, thank you very much, and have a splendid day.

Operator, Operator

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Thank you.