Q2 2025 Earnings Call Transcript

Good morning. My name is Brika, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vertiv's Second Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note that the call is being recorded. I would now like to turn the program over to your host today, Lynne Maxeiner, to begin. Please go ahead.

Great. Thank you, Brika. Good morning, and welcome to Vertiv's second quarter 2025 earnings conference call. Joining me today are Vertiv's Executive Chairman, Dave Cote; Chief Executive Officer, Gio Albertazzi; and Chief Financial Officer, David Fallon.

We have 1 hour for the call today. [Operator Instructions] Before we begin, I would 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. 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'll also present both GAAP and non-GAAP financial measures. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the investor slide deck found on our website at investors.vertiv.com.

With that, I'll turn the call over to Executive Chairman, Dave Cote.

Good morning, everyone. I have to say, I'm pleased with how well we've performed midway through 2025. We continue to outperform and deliver strong results. Gio and the team are executing very well, continuing to build a strong track record of financial performance. And our investments in R&D and capacity are paying off today as planned and positioning us well for the future.

The transformation at Vertiv continues to accelerate, and I am more excited today than I've ever been about what is ahead. We're in a digital revolution that's got a long way to go, and data centers remain fundamental to all of it. Our global scale and technology leadership aren't easily replicated, and we keep widening that gap. We maintain our proven strategy of driving growth through both organic expansion and strategic acquisitions to extend our market leadership.

Our recent Great Lakes acquisition announcement showcases our disciplined approach to deploying capital where we see clear strategic benefits and value-creation opportunities. Our M&A pipeline remains robust. And we'll continue to take this same approach, moving decisively when we find opportunities to enhance our technology leadership, engineering capability, global capacity and overall growth profile. Our ongoing investments in ER&D and capacity expansion ensure we stay ahead of market demand, while delivering the innovative solutions our customers expect.

This digital age is just getting started, and Vertiv is poised to capitalize on the massive long-term opportunities. With that, I'll turn it over to Gio to walk through the details of our performance and outlook. I'm confident he and the team will continue to execute at a high level and deliver value for our shareholders.

Thank you, Dave, and welcome, everyone. Thank you for joining us today. We go to Slide 3 now. I am quite pleased with what we have delivered in Q2. Our adjusted diluted earnings per share was $0.95, approximately 42% up from second quarter 24%, primarily driven by higher adjusted operating profit.

Our organic sales grew a very robust 34% year-on-year, with strong performance in the Americas, up in the mid-40s, and APAC up in the mid-30s. EMEA delivered high single-digit growth. For the first time, we surpassed $3 billion in orders this quarter. Well, not bad at all.

This is certainly promising in terms of long-term trajectory. Q2 orders were up approximately 15% from Q2 '24, and certainly not an easy comp, and up 11% sequentially from 1Q '25. Our trailing 12-month organic orders growth was 11%. Our Q2 book-to-bill ratio of 1.2x is particularly encouraging. We continue to build backlog at very high levels.

Momentum in our business is accelerating. Our Q2 adjusted operating profit was $489 million, up 28% year-on-year, driven by higher sales. Our adjusted operating margin of 18.5%, in line with guidance, is approximately 110 basis points lower than prior year. This was primarily driven by the net impact of tariffs.

Our updated guidance takes into consideration tariffs active on the 28 of July, reflecting a moderate improvement in the tariff situation compared to our Q1 guidance. The temporary costs of the supply chain and manufacturing transition to tariff-optimized footprint are higher than we initially estimated. We're also experiencing some temporary costs to deliver a steeper growth than expected and some executional challenges in EMEA. We expect all these factors will significantly moderate during the year, and we believe they will be materially resolved by year-end.

For Q3 and for the full year, we are raising our investment in ER&D and in growth compared to prior guidance. Our second quarter free cash flow of $277 million, though lower on a year-on-year basis, corroborates a strong cash generation trend, with adjusted free cash flow of $542 million in the first half, a robust growth of 24% year-on-year. This performance was driven by our improved operational execution, resulting in higher adjusting operating profit. We are raising the full year adjusted free cash flow guidance to $1.4 billion.

Our disciplined financial management is reflected in our strong balance sheet with a net leverage ratio of just 0.6x at quarter-end. We are raising our full year 2025 net sales guidance by $550 million to $10 billion. We expect organic growth to be approximately 24% for the full year. We're also raising our full year adjusted diluted EPS guidance to $3.80 or 33% higher than prior year.

We are taking our adjusted operating profit guidance to just under $2 billion at the midpoint. So 2025 is shaping up to be a strong year. With that, we move to Slide 4. Our TTM orders organic growth and our sequential orders growth, both at 11%, are testament to Vertiv's strong momentum in the market, particularly considering very strong orders in second quarter '24. Our backlog stands strong at $8.5 billion, up 21% versus prior year and 7% sequentially from Q1, supporting our increased guidance for the year. Our price is aligned with our expectations.

We are seeing robust pipeline growth across all regions, well balanced across our portfolio. And remember, these are tangible quoted opportunities. In EMEA, while 2025 full year net sales are expected to be flat compared to 2024, we are seeing sequential growth in the orders pipeline, providing optimism for 2026 and beyond. The regulatory environment is becoming more conducive to AI infrastructure investment, reflected in our customer discussions and pipelines.

While we are on the topic of orders, let me briefly explain a change in how we'll communicate orders. As we have consistently said, orders in this industry can be lumpy, and this lumpiness can sometimes create unnecessary stock market reactions for Vertiv. Beginning on our Q4 and full year 2025 earnings call, we will provide projected full year orders rather than quarterly orders and backlog information. We believe this better aligns with how we run our business.

We will provide updates on the full year projections quarterly as we progress through the year and as we deem necessary. Let's now move to the right side of the slide. The tariff situation remains quite dynamic and fluid, with the tariff perimeter changing frequently. And this can create inefficiencies in the playbook and execution as we adjust to a changing landscape.

This guidance is based on the tariffs in place on the 28 of July. We are vigorously executing tariff countermeasures. We believe tariffs will be materially offset exiting 2025. We are deliberately increasing spending in engineering and R&D, capacity and go-to-market to fuel growth. We are fine-tuning our supply chain as suppliers accelerate their localization efforts to address the tariff situation.

Our supply chain resilience is helping us well. As growth accelerates, our capacity expansion strategy continues to be two-pronged: strategic manufacturing and service investment ahead of anticipated growth, capacity liberation through Vertiv operating system productivity improvement. Let's now go to Slide 5. Gray space and white space no longer are separate spaces. Gray space is the traditional critical infrastructure that powers and cools the data center.

The white space is where the IT equipment, the IT stack, lives, the rack service, the compute infrastructure. With increase in rack density, the physical integration and interoperability between these spaces has become absolutely evident and critical. Think about it, with hundreds of kilowatts per rack, the mechanical, electrical infrastructure and the IT stack are so intimately connected, sharing the same space, that they need to be thought of as one system. This is where Vertiv's trends really come into play.

You will have heard me describe Vertiv as the connective tissue between the gray and the white space, between facilities and IT. Our traditional expertise in gray space is seamlessly becoming white space infrastructure expertise. White space deployment is becoming more complex, more time consuming, more multidisciplinary. This is a unique opportunity for advanced prefabrication to dramatically reduce fit-out complexity, reducing deployment time by an order of magnitude.

This is SmartRun, step-changes in how we think about wide space deployment. Allow me another angle. The IT equipment has traditionally had frequent refresh cycles. As density increases over time, this may drive regular refresh cycles of the white space mechanical and electrical infrastructure.

Let's now switch to the right side of Slide 5. Let's stay on this slide. We have announced a new acquisition, as you know Great Lakes, which is expected to close this quarter. We anticipate that this transaction will bring us extensive portfolio of high-end rack solutions and innovation capabilities that are essential in today's increasingly demanding AI infrastructure white space. Great Lakes portfolio includes custom racks, integrated cabinets, heavy-duty racks and cabinets and enhanced cable management solutions.

Great Lakes' high-end infrastructure solution technology, capacity and engineering expertise complement very well the rest of Vertiv's capabilities in the gray and white space. With manufacturing and assembly facilities in the U.S. and Europe, we anticipate Great Lakes will enhance our ability to serve customers with speed and scale. We are enabling the end-to-end infrastructure for AI factories. We're gaining and growing presence in the white space.

Our understanding of the entire system from power to cooling to IT infrastructure position us uniquely to solve the complex challenges that our customers face. And with that, I'll turn it over to David. David, over to you.

Perfect. Thanks, Gio. Turning to Slide 6. Let me walk you through our second quarter results. And starting on the left, another strong quarter for earnings growth with adjusted EPS of $0.95, which is up 42% from last year.

And that's primarily driven by higher adjusted operating profit and lower net interest. Once again, we delivered strong organic sales growth of 34%, almost $300 million above prior guidance. And compared to last year, Americas was up 43%; APAC up 37%; and EMEA, still influenced by a lag in AI infrastructure build, was up 7%. And as Gio stated, pipelines across all 3 regions continue to grow nicely, including EMEA.

Our adjusted operating profit of $489 million was up 28% from last year and $54 million higher than guidance. Our adjusted operating margin of 18.5% was down 110 basis points from last year, but in line with guidance, with the year-over-year decline primarily driven by tariffs, as expected. Now based upon operational leverage from the much higher volume, it would be reasonable to expect adjusted operating margin to be higher than the 18.5% actual and guide. However, as Gio mentioned, we experienced higher-than-anticipated operational efficiencies and execution challenges in the quarter in support of significantly higher volumes in addition to higher-than-anticipated supply chain and manufacturing transition costs to mitigate tariffs.

We expect some of these factors to continue in the third quarter, but be materially resolved by the end of the year and as we enter 2026. As implied in our full year guidance, we expect fourth quarter adjusted operating margin to be more than 23%, keeping us on track with our targeted 25% full year adjusted operating margin by 2029. And finally, on this page, adjusted free cash flow was down $60 million from last year's second quarter, primarily due to favorable trade working capital timing last year. But year-to-date adjusted free cash flow is up 24%. And as you will see in a few slides, we are raising our full year guidance by $100 million to $1.4 billion.

In short, you can likely check the box on free cash flow. Now moving to Slide 7, looking at our segment results. Americas had another strong quarter with organic sales up 43%, and that was driven by continued strength in colocation and hyperscale markets. And despite tariff headwinds, adjusted operating margin remained strong at 24%.

APAC's 37% organic sales increase was driven by strong growth across the region. Margin expanded to 10.6%, primarily driven by operational leverage and a discrete expense in last year's second quarter. EMEA's top line grew 7% organically in the second quarter, lagging the other regions as we expected. We anticipate EMEA sales will be down organically in the back half of 2025 and relatively flat for the full year.

But as a reminder, EMEA was our fastest-growing region in 2024, and we expect growth to reaccelerate based upon the healthy pipeline. Lower margin in EMEA is primarily driven by 2 things. First, we did have some operational execution challenges in the second quarter, that we expect to address in the coming quarters. Second, we made a deliberate decision to invest in fixed costs in the region ahead of expected growth, while expanding regional capacity pursuant to supply chain shifts to the U.S. in response to tariffs.

While this investment and these supply chain actions contribute to excess capacity and cost in the near term, they should be absorbed when volumes reaccelerate in EMEA. As mentioned, pipeline remains healthy, and we anticipate the strong pipeline to convert to top line as soon as 2026. Next, moving to Slide 8. We guide third quarter adjusted EPS of $0.97, 28% higher than last year. This improvement is primarily driven by an expected 22% increase in adjusted operating profit. On the top line, we expect another strong quarter of organic growth at 22%, with Americas in the mid-30s, APAC in the low 20s and EMEA down upper single digits, in part driven by a challenging comp in last year's third quarter.

We expect adjusted operating margin of 20%, relatively consistent with 2024, despite tariff headwinds, as we continue to leverage higher sales and drive positive price/cost. Implied is a 150 basis point sequential improvement from the second quarter primarily driven by progress in resolving some of the operational inefficiencies and execution challenges. Moving to Slide 9, let me walk you through our full year financial guidance. We are raising projected adjusted EPS to $3.80, 33% higher than last year, primarily driven by higher adjusted operating profit and lower net interest.

We are raising our full year top line guide by $150 million to $10 billion, with $110 million of this increase from favorable foreign exchange. The resulting underlying organic growth of 24% is driven by expected continued growth in the Americas and APAC, while we expect EMEA to be relatively flat. For adjusted operating profit, we are raising our full year guidance to just under $2 billion, up 28% from last year. And as Gio mentioned, this guidance assumes tariffs active on July 28. We expect, all other things being equal, a possible downside scenario from potential August 1 tariffs as currently understood, and things are changing rapidly and somewhat challenging to quantify.

But we believe that would still place our full year adjusted operating profit within our guidance range for adjusted operating profit. Full year adjusted operating margin is projected to be approximately 20% at the midpoint, 60 basis points higher than last year despite tariff headwinds, and 50 basis points lower than prior guidance. We continue to drive margin improvement, including positive price/ cost and productivity. And implied in our guidance is fourth quarter adjusted operating margin in excess of 23%, once again, keeping us on track to attain our long-term target by 2029. And finally on this page, we are increasing our full year adjusted free cash flow guidance to $1.4 billion, up $100 million from prior guidance, driving full year adjusted free cash flow conversion to 95% as we continue to drive initiatives to optimize trade working capital.

And when you piece it all together, the growth trajectory, the margin progression and the free cash flow performance, these numbers certainly demonstrate the continued strength of our execution and our ability to drive significant growth while expanding margins. We tucked the fourth quarter guidance slide in the appendix, and if you look at the exit rates across all financial metrics, we believe we should be very well positioned for a strong start to 2026. And with that said, I turn it back over to Gio.

Well, thank you, David. Thanks a lot. We go to Slide 10. So some key thoughts here to wrap up. Growth is certainly ongoing and it is here to stay.

We have demonstrated the ability to meet our customer needs and to gain market share, delivering a 30% sales growth in the first half of '25. While this has required accelerated investment in engineering and R&D capacity and go-to-market, we are aligning execution to this speedier growth rate. We are vigorously addressing the temporary margin challenges. This has my and my team's full attention. I'm confident we will see constant improvement.

We have raised 2025 guidance for adjusted diluted EPS, net sales, AOP and adjusted free cash flow. The speed of technological evolution isn't abating and the industry is changing quite dramatically. We're driving this change and helping to shape the future of data center infrastructure. Lastly, let me highlight 2 particularly exciting developments that demonstrate our technology leadership and innovation in the market.

Let's start with our collaboration with CoreWeave, which showcases Vertiv's position at the forefront of AI infrastructure. With CoreWeave and Dell, we're the first to launch and deploy NVIDIA's GB300 NVL72. This follows our head start with GB200 NVL72 reference designs. Our infrastructure offering is always at least 1 GPU generation ahead, which is absolutely critical for our customers. And let me continue with our collaboration with Oklo.

With the data center industry keenly focused on accessing the increasingly large sources of power, power generation, our collaboration with Oklo is about making access to advanced nuclear power plants easier. Working on power and thermal reference architectures tailored to Oklo's great advanced nuclear power plant technology, we will enable this to happen at scale and in ways that significantly enhance the overall data center efficiency. These collaborations demonstrate how Vertiv is actively shaping the future of the data center infrastructure, working with innovative partners to solve the industry's most pressing challenges while maintaining our focus on efficiency, reliability and sustainability.

I conclude by saying that the industry is effervescent, optimistically intense in driving acceleration. We are raising our full year guidance, and we are confirming our long-term margin objective. We are making sure we continue to lead the industry forward through this acceleration for the years to come. With that, let us start the Q&A session.

And over to you, Brika.

[Operator Instructions] The first question comes from Steve Tusa with JPMorgan.

JPMorgan Chase & Co, Research Division So just on the margin side, I think, you're going to be exiting the year at like a 30 -- mid-30s incremental margin, which I think is relatively something that we would target, I think, over the long term that you guys have talked about. I know you're continuing to invest every year and there's always some incremental friction as you're delivering at this rate, which is pretty dramatic. But is there any reason why we wouldn't think about '26 as a more normal year on margins given your kind of easy comps in that exit rate?

Certainly, the direction of speed coming out of 2025 is encouraging in terms of the long trajectory -- long-term trajectory. We -- I was vocal in the script, thinking in terms of continue to believe that our objectives in terms of long-term margins are correct. So I would think that probably too far from what we think the future could look like, Steve.

Your next question comes from Amit Daryanani with Evercore.

I guess I was hoping, Gio, you could spend a little bit of time on the strength that we're seeing in both your backlog and orders right now. And maybe just touch on 2 fronts. One, are you seeing a shift in duration of your orders right now? Or maybe you can talk about the range of what that order book of backlog looks like?

That would be really helpful. And then secondarily, can you just touch on the diversity of this backlog. You mentioned CoreWeave, I think, at the end of your comments, and certainly, the neocloud seem to be ramping up in a much bigger way. So I'd love to just understand how do you view the duration of this backlog and then also the customer diversity that's perhaps starting to happen over here.

Amit, I will take this as a one question, let me put it this way. So 2 aspects of your one question. One is the, what is the duration? And what is the mix in terms of time frames of our backlog and pipeline?

Backlog is pretty much similar to what we have seen historically. There is no kind of either a dramatic elongation or dramatic shrinkage of the backlog. If anything, what we see, and it's quite reassuring, we like it, is that some of our customers would like to have staff earlier, and there is an appetite to -- for us to deliver, if you will. When we can deliver, and we can deliver, as we have demonstrated in the second quarter, we are increasing the customer base that is ready to receive.

That's a good sign for the industry as a whole. When it comes to orders, let's say, top pipeline more than orders, because orders and, what I said, backlog is pretty much like-for-like, it's the same, when the order is received. In the pipeline, we have a little bit of an elongation, which is a positive elongation. Don't think about anything that distorts the shape between, for example, what is 6 months, next 6 months or next 12 months vis-a-vis beyond the next 12 months.

But there is a little bit more elongated visibility. But again, nothing that dramatically changed the shape. We have a nicely kind of actionable pipeline that supports our growth ambitions. There was an aspect about diversity.

I'd say that clearly, if we think about the part of the market that grows the fastest, we're certainly thinking what the -- what we call the call it hyperscale. And you know that is quite a large container for us. That includes certainly hyperscale, traditional colocation, sovereign and definitely neocloud. So it's well balanced in that respect.

We now have Jeff Sprague with Vertical Research Partners.

I'm going to sneak an unrelated two-parter in here too, if I can. Just first on tariffs and inflation. Just given this kind of remarkable demand pulse you're seeing, do you have kind of the commercial leverage to fully recover tariffs? We're just talking about some kind of delay in terms of moving through the order backlog and converting to sales.

And then I'm sorry, Gio, could you just maybe address, a little scare through the market a couple of weeks ago on AWS delivering some kind of -- or developing some kind of liquid cooling application. How you put something like that in context to your business?

Well, I really have a hard time, Jeff, reconciling these 2 questions into one. So let me start from the AWS one. So in general, think in terms of hyperscalers having certainly a very strong opinion on how they want their infrastructure to be. Now no 2 hyperscalers have the same behaviors.

No 2 hyperscalers have the same design philosophy. But certainly, with every single hyperscaler, you usually have a very strong relationship, and you have to be involved in the technology that very often, together with them, is developed. So I don't want to overelaborate on the specific case because I'll let AWS talk about that. But in general, think about us being always connected with hyperscalers.

And as I said several times, it's very important to be in the labs with them, to having our engineers and their engineers working together. And that will bring good things about that could be kind of a customization of products that are in our portfolio or us working on the technology exactly the way they want it. So I don't think there should be any scare. This is not an anomaly in the way the market works.

And we are here to scale with our hyperscale customers. We are here to co-engineer with them.

We now have a question from Nigel Coe with Wolfe Research.

Gio, I promise I'll keep this to one question. No two-parters within one question, just one question. I think -- so -- let's see. You be the judge.

So can we just talk about win rates? There's obviously a lot of speculation around the evolution to liquid cooling and lots of new entrants and the like. So just wondering, in terms of your win rate, especially on the AI infrastructure side of things, how is your win rate comparing to the last 2 or 3 years? And here comes the and.

Is there any change in the way that the hyperscalers are procuring equipment? I'm just wondering if the system-wide approach is starting to gain traction as opposed to RFPs for specific components of the system.

So in general, we will not go in the details of win rates for AI infrastructure, not AI infrastructure. Remember that already probably a year ago, we were saying, hey, being too analytical about what is AI, what is not AI is false precision. But in general, we see good stability in our win rate. Now we should go product line by product line, we should go BU by BU.

But in general, when we see things in aggregate, we have stability of win rates, which is, of course, you combine win rates and pipeline, specifically a good sign. And we don't see a dramatic way or any significant way in which hyperscalers go about procuring their infrastructure component or their solutions and systems. And again, there are some hyperscalers who have been historically very much, "Oh, I want to design it, and yes, consult with you as I design, and then you will be part of our, let's say, supply chain for the specific system." And there are others that sit with you and say, "Hey, these are my needs, what you want to do -- how do we design around my needs, what you have around my needs?" Clearly, most of people think in terms of suppliers as a multisource for resilience.

But then again, in that case, from that point of view as well, it is a customer-by-customer type of decision and philosophy. So in general, nothing dramatically different, even as the technology of what they buy is moving with the technology of the industry, the technology evolution of the industry.

We now have Scott Davis with Melius Research.

I want to drill down if we can into the operational inefficiencies. And just Gio, if you can just talk a little bit about root cause. Are these the standard things of kind of premium freight and overtime labor and third shift and efficiencies and stuff like that? Or are there other kind of hiccups that you're having while you're adding capacity as far as getting components, getting tooling and stuff like that?

I mean what -- just a little bit more granularity, I think, on where you're seeing those inefficiencies, I think, would be helpful.

Yes. I think it's a combination of things, Scott. And we have addressed that during the -- as we're going through the slides. But I really like to think about it in 3 ways.

One is there is a tariff transition. I mean we talked about tariffs -- setting tariffs, et cetera, in a steady state. But when you transition from certain footprint of supply chain and manufacturing to another one that is more adjusted to the tariff, you have to involve new sources. Sometimes you have to have new certification.

You have -- you move a backlog from one place to another. You have stops and goes. That, of course, inject inefficiency. And some of that, of course, you can fight, and you do, and we do.

Some other is what you have to face. If you then think that this is ongoing anyway, but ongoing and overlap to a situation in which we're growing at 34%, then you have that compounding with exactly what you were saying. So you have to have to enable that growth more over time. You have premium freights.

And that is a premium freight for that. That is the premium freight for the tariff reconfiguration. It's probably a combination of the 2. So clearly, all these 2 elements -- both these elements -- sorry. Both of these elements, the tariff transition and the strong acceleration, are normalizing, and are normalizing as we make more capacity available as we design the way we operate and align the way we operate to a higher level of growth.

So you were talking about retooling. Let's talk about retooling that would probably be more a tariff transition, using it to get -- extending a little bit the definition of that. But then there will certainly be the overtime, the backlog movements, the freights. We talked about some other EMEA-specific operational, executional challenges that are specific to a part of our business that we are addressing, with focus, and dare I say, with my -- even my direct involvement on certainly more than a weekly basis.

All things that, as I was saying, we believe, will be in full control.

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

So one of the things that sort of came up last quarter during various channel checks is that there are a lot of teething pains on liquid cooling systems in the industry. And I would guess that this sort of bodes well for service contracts. And any color or commentary on growth rates for thermal service contracts or liquid cooling? Because I think at the Analyst Day last year, people have sort of thought that this could be an attractive growth opportunity for Vertiv.

Yes. Thank you, Andrew. So certainly, let's say, if you think about the cooling -- and I go back to what I was saying when we're going through the slides. The degree of intimacy, interoperability between a cooling system, liquid cooling system and a multimillion dollar rack, is enormous.

And the system is quite complex from a technology standpoint, from a calibration, balancing standpoint. So we are fully convinced, and we see that indeed being the case, that our service strength is really making a difference. In the deployment of liquid cooling at scale, don't forget scale is a big element here, but also during the life cycle of the liquid cooling system. So yes.

The answer is a straight yes. We believe that liquid cooling is helpful and will be certainly favorably in terms of our thermal services, thermal contract growth, is an area we truly believe will be strong going forward.

We now have Michael Elias with TD Cowen.

Just curious, as you think about the evolution of what goes into the data center, i.e., increasingly looking at taking a medium voltage directly to the rack and rack density is getting up to 1 to 2 megawatts per rack, how do you think about your current product footprint? And any ways that you need to evolve your offering in order to keep pace with the evolution inside the data center?

Well, thanks, Mike. I think this is certainly something that is happening, is very clearly in our road maps. And you're right, just as we saw the thermal or the cooling infrastructure evolve, and it's not finished, of course, it will continue to evolve. By the same token, the same will happen on the power side of things.

You heard us -- you probably heard us or people heard us vocally support NVIDIA's plan to have a higher, let's say, voltage type of rack power distribution in general. But this, of course, will have reverberations across the entire power infrastructure. So yes, the portfolio is evolving. What we are really happy about and we nurture very carefully and very intensely is the relationship we have with the key players, be them silicon or hyperscalers, which we together define what the future will be like 1, 2, 3 years out, and align our portfolio and our technology.

If you think about this kind of a higher voltage DC power, that's something that, of course, is very -- leverages very well our decades- long DC power technology. But you can think about this evolution, again, I want to stay on the power side, is something that is even broader. As data centers will become more and more self-sufficient from a power generation standpoint, and we know that, that is certainly a trend, not the sole trend, but it's certainly a trend. Well, then you'll see, back to my Oklo point earlier, as you see that, the powertrain, the power infrastructure will be -- will need to be very well-orchestrated exactly from power generation all the way to inside the rack.

And there will be various architectures that really will depend on, again, the type of philosophy and also the type of use of a certain data center. How much flexibility you want to have 2 different type of loads? So long story short, the system is becoming more important. The system is becoming more complex.

And this is an exercise that we are, of course, engaging in, and we are very excited about.

We now have Nicole DeBlase with Deutsche Bank.

I just had a question on margin. So the guidance implies like a 10 basis points year-on-year decline in margins in the third quarter, and then a pretty big step-up to like over 200 basis points of expansion in the fourth quarter. So probably a question for David. But can we kind of walk through some of the puts and takes that give you guys confidence in that step-up?

Yes. I think it's 2 things, Nicole. Number one is the benefit of operational leverage. And you can get our exact Q4 numbers in the appendix, but there's over $200 million increase in sales expected in Q4 versus Q3. So that definitely provides the benefits of operational leverage.

And the other bucket is simply addressing the operational inefficiencies and execution challenges that we've seen in Q2 into Q3. Once again, we believe all of these should be resolved in Q4. So it may be oversimplifying things, but I think those are the 2 buckets that drive the improvement from Q3 to Q4.

Simple is great.

We now have Amit Mehrotra with UBS.

Just, Gio, at the front of the call, you had talked about the regulatory environment getting better for AI infrastructure and that was being reflected in your pipeline. Can you just give us a little bit more color on that and what specifically is getting better? And also just -- I know you don't like commenting on orders for obvious reasons, but you have been quite generous in talking about trailing 12-month orders and the expectations there. We're getting past these tougher comps here where I think there looks like a possibility for TTM orders to reaccelerate.

Wondering if you would engage with me in that type of conversation.

Another case of very clear 2 questions these guys does as one. So let me address the regulatory environment and be patient with me. So this is in general true. If we think about the U.S. environment, of course, we see a lot of attention from the administration for the sector.

It's not just a sector in terms of data center itself, but elements that are then conducive very much to data center growth that is all around power and power grid and power generation. So that's what I referred to. But also my comment was a little bit oriented towards EMEA, where we see national government, the EU, but also places like the U.K., they're more aware of the importance and the strategic importance of AI. So that is slowly, as we said, slowly, but surely, starting to head in the right direction.

And one thing that I haven't mentioned this time that I'm fully convinced about is that one of the reasons why Europe is maybe a little lagging, we're talking about a coiled spring. Is that so much kind of attention and time and resources are really focused on North America and the U.S., that sometimes they are the same players, and the same players that play both in the U.S., North America and Europe. That's even more so true than it is, if you will, with Asia is its own dynamics, and positive dynamics, I must say. So you will see that a lot of the attention is absorbed by what happens in the U.S., and we believe times will soon be mature for an acceleration in Europe and EMEA.

What about the trailing 12 months?

That's the second question. That's the second question. And as we said, we -- I would be guiding orders, and that's not what we do. And it was the second question. Be patient with me.

We now have a question from Chris Snyder with Morgan Stanley.

I wanted to ask on gross margin. We have obviously come under some pressure here in the first half, after a period of very healthy expansion. Is this only a function of tariffs and some of the inefficiencies discussed earlier? Or are there also headwinds from whether it be mix or new technologies ramping, i.e. liquid cooling?

When you guys look at the backlog, is the expectation that gross margin return to expansion in Q4 and that kind of helps provide that operating lift? Or is that still a little bit further out?

A couple of things I'd be pleased to add. We are happy about the new technologies, and I think the new technologies corroborate our value story and certainly our margin story. As we explained, there is -- there are tariff elements and, certainly, growth, inefficiency in the operational aspects that we, I think, have discussed. Those are the -- really the main elements.

And when it comes to margin, and the backlog margin because we do not go in those level of details, but certainly, we factor the margin in our backlog when we talk about -- when we give out guidance in general. I don't know if you want to add anything, David?

Yes. Just on the topic of mix. Mix could be a factor quarter-to-quarter based on larger projects. But I'll tell you, for the full year, margin will not have a negative -- or I'm sorry, mix will not have a negative impact on our margin. If anything, it will be slightly positive.

We now have the next question from Andy Kaplowitz with Citigroup.

Gio, I think in the past, you said that the market and Vertiv are trending toward the high end of your 15% to 17% growth CAGR for hyperscaler and colocation revenue growth to '29, and your 12% to 14% growth for Vertiv. But given the recent order momentum, are we thinking that growth could be even higher, modestly higher rates, especially given you're seeing a broadening of AI spend, I think, in the sovereigns or enterprise? Or do you say the order ramp has been more what you've been expecting, maybe just slightly faster?

I think, early to think in terms of, let's say -- or a correction or a change in our, let's say, market growth expectations. I think it would be premature. Certainly, we like what we see in terms of market demand. Certainly, going back to the point you were making that range for hyper and colo that we gave, the 15%, 17%, we're probably thinking about the upper end.

As usual, we continue to look at the market, to evaluate the margin. Now it would be premature. But certainly, as we're saying in this market, we are taking market share. And yes, we are happy with the trajectory.

But again, we're not even shocked in terms of that because we've been talking about our pipeline getting stronger for quite some time. And again, not commenting on any specific quarter because of the lumpiness that we have several times discussed. We think that from a trailing 12, the momentum is the right one and is momentum that certainly implies a market share gain.

We have a question from Mark Delaney with Goldman Sachs.

Goldman Sachs Group, Inc., Research Division You said you expect to generate about $1.4 billion of free cash flow for this year and plan to use about $200 million for the Great Lakes acquisition. Can you speak to your priorities for the rest of the free cash flow and if you expect M&A to become a more regular part of your capital allocation framework from here?

Well, thank you, Mark. Certainly, M&A is an important element in our capital allocation strategy and certainly in our value -- more broadly speaking, value creation model. And we've been very vocal about that. We're happy about what we have recently announced.

So it is an important part. So again, it's an important part that we address with the key focus. We have a strong process and a very active pipeline. What exactly will happen would be obviously super premature to say.

But we're not shy and we'll not be shy if the right timing and the right thing mature to the point that we can act on. So I am certainly pleased with how much stronger our engine in this respect is. So I don't want to predict anything right now, but certainly, we have the means, we have the credibility, and we have the process in place.

Our final question comes from Noah Kaye with Oppenheimer.

Oppenheimer & Co. Inc., Research Division So Gio, you talked at DCD earlier this week about the trend towards modular and prefab solutions as really accelerating. And I would love to understand to what extent your backlog has started to remix in that direction and perhaps whether we can tie that trend to the demand acceleration you're seeing.

Well, thank you. That is certainly a trend that we see. We know that the industry needs speed, and speed in construction is paramount, full success for our customers. But also, as I said several times, this is a construction industry.

And if you have to build very, very complex systems like data centers, on site, at speed, then there certainly are challenges, shortages, manpower, skilled labor shortages, and surely things can be done better in a prefabrication setup and mode. So yes, we see an acceleration in the modular business. Don't think the modular business as something else from what we do. For us, modular business is prefabricating a lot of our technology.

So we're not just a regular kind of an integrator. We indeed are absolutely not an integrator. We are prefabricating the technology that we own. And that makes a big difference.

So it's not like, oh, thermal is going down, power is going down, and prefabrication is going up. No. It is really integral, is almost like a wrapping around in our technologies and one that can create a lot of value to our customers. And this can be multiple things.

If you take our SmartRun, our SmartRun that I was talking about earlier, you will have power racks, power distribution. You will have a secondary fluid network. You can include in there everything liquid cooling, busways, controls, you name it. So it's really a way to package increasing the value that we deliver to our customers.

Thank you. This concludes our question-and-answer session. And I would like to turn the call back over to Gio for any closing remarks.

Well, thanks a lot, and thank you for all the questions and the time today. Certainly, it's worth reiterating how excited I am and we are about the future of Vertiv. We have demonstrated and are demonstrating our ability to deliver strong growth and profit even in the face of a complex operating environment. Certainly, I'm pleased with our progress and -- but you know, never, never satisfied.

The market opportunity ahead of us is a significant, certainly driven by the accelerating digital transformation and the insatiable, dare I say, demand for data center infrastructure. We believe Vertiv is uniquely positioned to capitalize on this opportunity with our complete portfolio, deep customer relationships and strong execution capability. So overall, I want you to know that I and the Vertiv team remain laser-focused on delivering for our customers and investors. The future has never been brighter, and I'm excited to continue this journey with all of you.

So thank you, and have a great rest of the day.

Thank you. This concludes today's conference call. Thank you all for attending today's presentation. And you may now disconnect.