APi Group Corporation (NYSE:APG) Q2 2023 Earnings Call Transcript

APi Group Corporation (NYSE:APG) Q2 2023 Earnings Call Transcript August 5, 2023

Operator: Good morning, ladies and gentlemen, and welcome to APi Group’s Second Quarter 2023 Financial Results Conference Call. [Operator Instructions] Please note this call is being recorded. [Operator Instructions] I will now turn the call over to Adam Fee, Vice President of Investor Relations at APi Group. Please go ahead.

Adam Fee: Thank you. Good morning, everyone, and thank you for joining our second quarter 2023 earnings conference call. Joining me on the call today are Russ Becker, our President and CEO; Kevin Krumm, our Executive Vice President and Chief Financial Officer; and Sir Martin Franklin and Jim Lillie, our Board Co-Chairs. Before we begin, I would like to remind you that certain statements in the company’s earnings press release announcement and on this call are forward-looking statements, which are based on expectations, intentions and projections regarding the company’s future performance, anticipated events or trends and other matters that are not historical facts. These statements are not a guarantee of future performance and are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements.

In our press release and filings with the SEC, we detail material risks that may cause our future results to differ from our expectations. Our statements are as of today, August 3, and we undertake no obligation to update any forward-looking statements we may make except as required by law. As a reminder, we have posted a presentation detailing our second quarter financial performance on the Investor Relations page of our website. Our comments today will also include non-GAAP financial measures and other key operating metrics. A reconciliation of and other information regarding these items can be found in our press release and our presentation. It’s now my pleasure to turn the call over to Jim.

James Lillie: Good morning. Thank you, Adam. APi delivered another strong quarter of results, including record net revenues, adjusted EBITDA and adjusted diluted earnings per share in an evolving macro environment. We continue to be pleased with the momentum APi is building with an outstanding first half of 2023. Russ and Kevin will speak to the performance of the business in more detail, but APi’s consistently strong financial results speak to the direction we are heading and the strength of the company’s recurring revenue service-focused business model as well as the discipline of the organization and its leadership team. We started this journey with Russ and the team nearly 4 years ago as a U.S.-focused business with approximately $4 billion in revenues.

Today, we are significantly larger with an expectation of delivering over $7 billion in revenue in 2023. The quality of the business and our financial performance has also improved significantly. We are the number one provider globally in a growing, highly fragmented fire and life safety market. We have confidence in the team’s ability to expand adjusted EBITDA margins to 13% in 2025 and beyond as we continue to increase our inspection service and monitoring revenues. Since becoming a public company, the team has made measurable progress and demonstrated a track record of disciplined, predictable and thoughtful decisions regarding capital allocation, maintaining our focus on tuck-in M&A at appropriate multiples while consistently delivering financial results above expectations across a variable macroeconomic backdrop.

We have great confidence in the business, and we believe that our laser focus on our long-term 13/60/80 value creation targets will generate outsized investor returns through 2025 and beyond. As a reminder, these include organic revenue growth above the industry average: adjusted EBITDA margins of 13% in 2025, long-term revenues of 60% from inspection, service and monitoring and long-term adjusted free cash flow of 80%. We look forward to updating you on the progress in the second half of the year. And with that, I will hand the call over to Russ to talk about the real results.

Russell Becker: Thank you, Jim. Good morning, everyone. Thank you for taking the time to join our call this morning. Jim mentioned our 13/60/80 long-term shareholder value creation model that you see once again included in our presentation. As I mentioned last quarter, we are relentlessly focused on driving this strategy with our specific focus of achieving 13% adjusted EBITDA margins by 2025. I continue to speak to our leaders about how they can help us deliver on this strategy when I’m visiting our locations around the world. We are aligned as an organization in what we want to achieve and how to make it happen. During today’s call, I will begin my remarks by briefly commenting on our record second quarter results as well as our continued progress towards delivering on our stated strategic goals in a macro environment that continues to be volatile.

I will then touch on the long-term organizational investment behind our inspection-first model and the benefits that it’s driving in our financial results. Finally, I’ll recap our recent M&A activity and the positive momentum of the business before turning the call over to Kevin, who will walk through our financial results and guidance in more detail. As you’ve heard me say on prior calls, the safety, health and well-being of each of our 29,000 leaders remains our number one priority. We remain grateful for their hard work and dedication to APi. We believe we have a differentiated approach to leader development for every teammate at APi but specifically for our field leaders, who interact with our customers on a daily basis. We will always prioritize investing in the men and women in the field as human beings and aim to provide each of them with training, leadership development and advancement opportunities.

At APi, our field leaders have careers, not just a job. We prioritize this investment because we recognize that our success only happens when our branches and field leaders are successful. This commitment is one of the foundational principles we believe will continue to enhance shareholder value. Turning to the second quarter. I’m again pleased with the record results delivered by our global team as we continue to see robust demand for the services we offer across the business. Net revenues grew organically by 7.6% in the quarter and by 9.7% year-to-date, reaching $1.8 billion for the three months ended June 30, 2023, representing the ninth straight quarter of mid-single-digit or higher organic growth. Importantly and in line with our strategic initiatives, we saw a double-digit increase in inspection, service and monitoring revenue as we march towards our long-term goal of 60% of total net revenues from inspection, service and monitoring.

U.S. Life Safety continued its strong performance with organic growth of approximately 12% in the second quarter and approximately 16% year-to-date led by double-digit plus inspection growth, which we have achieved in our U.S. Life Safety business each quarter since the pandemic. In line with our strategic initiatives, we continue to see strong year-over-year improvement in adjusted gross margin in the second quarter, up 160 basis points. I am pleased with the leadership team’s on-going commitment to driving gross margin improvements through pricing activities, growing higher-margin service work and maintaining discipline in customer, project and end market selection. I want to take a moment to update you on a critical investment we have made over the last decade to become an inspection-first organization and how this commitment drives financial results, allows for more disciplined customer and project selection and helps to build a protective moat around the business.

We fundamentally believe that targeting statutorily mandated inspections at existing facilities and providing excellent service on those inspections drives repeatable business and creates sticky customer relationships. When those customers consider expansion plans, we are no longer competing solely on price, but instead can leverage our position as an excellent service provider with our customers to drive higher-margin installation opportunities. We target double-digit quarterly growth in core inspection revenues, and we are continuing to build what we believe is the best global inspection sales organization focused on driving this growth. But it comes down to a lot more than just selling the inspection. Inspections are a highly coordinated process requiring field and office collaboration with the customer.

This multistep process requires a significant amount of infrastructure and training to do well as well as the right leaders in the field. We’ve equipped our field leaders with best-in-class technology and invested in multiple instruction training centers and programs to help to develop our field leaders and help enable them to provide great service to our diverse customer base. Most competitors would rather pursue large installation jobs than recurring, higher margin, smaller invoice inspection work. Our investment in and commitment to the inspection-first model over the last decade is a key differentiator and has made growing inspection increasingly within our control. We believe we are ahead of any competitor who would attempt to replicate this strategy.

And our investments, sales force and scale have created a large barrier to entry. As a reminder, in most cases, these inspections need to take place at least once per year or in some cases, more frequently. And we have data that every dollar of core inspection revenue leads to an average of $3 to $4 of subsequent service revenue. On average, core inspection and service revenue comes in at 10%-plus higher gross margins than project revenue. We included a slide in the presentation that shows the 10-year journey of one of our branches that was an early adopter of the inspection-first strategy and its impact on that brand’s profitability over time. An underappreciated benefit of continuing to grow inspection, service and monitoring revenues beyond serving our customers better is the ability to then be much more selective on the installation work we choose to do, resulting in margin expansion on the project side of the business as well.

For this specific branch, EBITDA margins expanded from low single digits to mid-20% in less than 23 — in less than 10 years. You can see the benefit of this approach come through in our consolidated results where we have delivered gross margin expansion for 6 straight quarters and an improved quality of the projects in our backlog, which remains healthy and strong. Our leaders continue to execute this strategy across our branch network, and I’m excited for the long-term opportunity in our international business where we are only in the early stages of instilling this strategy. The international business continues to show progress with another quarter of solid growth as we continue to be intentional about targeting only work that is additive to achieving our 2025 13% adjusted EBITDA margin target.

The $100 million value capture plan, which is another key contributor to our 13% target, remains on track. Moving on to M&A. Our free cash flow generation and EBITDA growth in the first half of the year gives us confidence in our ability to reduce net leverage in line with our target net leverage range of 2 to 2.5 times near the end of the year while returning to bolt-on M&A. As you may have seen in our July press release, we announced a return to bolt-on acquisitions that are immediately accretive to our adjusted EBITDA margin before synergies. The markets we operate in are highly fragmented, and the team remains focused on identifying the most attractive opportunities within our robust M&A pipeline. I’m excited to continue to add new businesses and their leaders to the APi family.

We have strong momentum across our global platform as we enter the back half of the year, allowing us to again increase our full year financial guidance. Kevin will provide details on our updated guidance. In summary, while we remain focused on executing in the back half of the year, I’m proud of our team and how we delivered on our commitments and produced record financial results so far in 2023. Our field leaders continue to be the driving force of our performance. I’m truly grateful for what each of them has done to get us to where we are today. I would now like to hand the call over to Kevin to discuss our financial results and guidance in more detail. Kevin?

Kevin Krumm: Thanks, Russ. Good morning, everyone. Reported net revenues for the three months ended June 30, 2023, increased by 7.4% to $1.8 billion compared to $1.6 billion in the prior year period. Net revenues increased organically for the same period by 7.6% driven by strong organic growth in both Safety and Specialty Services led by double-digit growth in service revenues. In the second quarter, growth in the Safety Services segment was approximately one half driven by price and one half by volume, while growth in Specialty Services segment was primarily driven by increased volumes, which were measured through labor hours. Adjusted gross margins for the three months ended June 30, 2023, grew to 28.3%, representing a 160 basis point increase compared to the prior year period driven by price increases, outsized growth in service revenues and project margin expansion across both segments.

These factors were partially offset by inflation, which caused downward pressure on margins. Adjusted EBITDA increased by 16.7% on a fixed currency basis for the three months ended June 30, 2023, with adjusted EBITDA margin coming in at 11.5%, representing an 80 basis point increase compared to the prior year period primarily due to the factors impacting gross margin, partially offset by investments to support revenue growth and the continued build-out of our global capabilities and infrastructure. Adjusted diluted earnings per share for the second quarter was $0.41, representing a $0.04 increase compared to the prior year period. The increase was driven primarily by strong organic growth and margin expansion in both Safety and Specialty Services, partially offset by an increase in interest expense, representing a $0.03 headwind to adjusted diluted earnings per share in the quarter.

I will now discuss our results in more detail for Safety Services. Safety Services reported revenues for the three months ended June 30, 2023, increased by 6.9% to $1.2 billion compared to $1.1 billion in the prior year period. Net revenues increased organically by 7.3% driven by double-digit core inspection revenue growth and robust growth in U.S. Life Safety, partially offset by planned customer attrition in our international business and increased discipline in customer and project selection in our HVAC business. Adjusted gross margins for the three months ended June 30, 2023, was 32.4%, representing record high adjusted gross margin and a 180 basis point increase compared with the prior year adjusted gross margin driven by price increases, improved business mix on inspection service and monitoring revenue as well as significant improvement in project margins, partially offset by inflation, which caused downward pressure on margins.

Adjusted EBITDA increased by 18.7% on a fixed currency basis for the three months ended June 30, 2023. And adjusted EBITDA margin was 13%, representing a 120 basis point increase compared to the prior year period primarily due to the factors impacting adjusted gross margin, partially offset by investments made to support revenue growth. I will now discuss our results in more detail for our Specialty Services segment. Specialty Services reported revenues for the three months ended June 30, 2023, increased by 7.1% to $555 million compared to $518 million in the prior year period primarily driven by double-digit growth in service revenues led by growth in specialty contracting, infrastructure and utility markets. It’s partially offset by continued disciplined customer and project selection.

Adjusted gross margin for the three months ended June 30, 2023, was 19.1%, representing a 170 basis point increase compared to the prior year period primarily driven by strong organic service revenues as well as significant improvement in project gross margins driven by disciplined customer and project selection. Adjusted EBITDA increased by 15% for the three months ending June 30, 2023. And adjusted EBITDA margin was 12.4%, representing an 80 basis point increase compared to the prior year period primarily due to the factors impacting adjusted gross margin, partially offset by timing of some employee-related expenses and other onetime costs. We continue to focus on driving free cash flow conversion improvements year-over-year, progressing towards our long-term goal of 80% free cash flow conversion.

For the three months ended June 30, 2023, adjusted free cash flow came in at $91 million, reflecting an improvement of $28 million versus the prior year period and an adjusted free cash flow conversion of 45%. For the six months of the year, which, as a reminder, is seasonally slower than the back half of the year, we delivered $75 million improvement in free cash flow when compared to the first six months of 2022. Free cash flow generation has been and continues to be a priority across all of APi. And our performance in the first half of the year positions us to deliver on our 2023 guidance of at or above 65% adjusted free cash flow conversion, representing an adjusted free cash flow delivery of over $500 million at the midpoint of our updated adjusted EBITDA guidance.

At the end of Q2, our net debt to adjusted EBITDA was approximately 2.9 times even with the return to margin accretive bolt-on M&A in the quarter. We remain laser focused on cash generation and deleveraging through our stated long-term net leverage target of 2 to 2.5 times with current expectations to be below 2.5 times net debt to adjusted EBITDA by year-end 2023. Our balance sheet remains strong with a weighted average maturity of approximately 5 years with the earliest maturity in 2026. I will now discuss our guidance for Q3 and full year 2023. As a reminder, our guidance incorporates the expected impact of foreign exchange fluctuations, which we expect to be a modest tailwind in the second half of the year when compared to 2022 after being a headwind in the first half of 2023.

I’m pleased with the performance year-to-date and the momentum of the business, which gives us confidence to raise our prior full year guidance for reported net revenues and adjusted EBITDA. We now expect full year reported net revenues of $7.015 billion to $7.075 billion, up from $6.875 billion to $7.025 billion at current currency expectations. This represents reported net revenue growth of approximately 7% to 8%. We now expect full year adjusted EBITDA of $765 million to $785 million, up from $740 million to $780 million, which represents reported adjusted EBITDA growth of approximately 14% to 17% and adjusted EBITDA margin of approximately 11% at the midpoint. In terms of Q3, we expect net revenue — we expect reported net revenues of $1.86 billion to $1.89 billion.

This guidance represents reported net revenue growth of approximately 7% to 9%. We expect Q3 adjusted EBITDA of $215 million to $225 million, which represents reported adjusted EBITDA growth of approximately 16% to 21%. For 2023, we anticipate interest expense to be approximately $150 million, depreciation to be approximately $85 million, capital expenditures to be approximately $95 million prior to any potential sale of equipment and our adjusted effective cash tax rate to be approximately 24%. We expect our adjusted diluted weighted average share count for the third quarter to be approximately $272 million. Overall, I’m pleased with the results delivered by our global team in the second quarter and first half of 2023. I look forward to sharing more updates on our progress throughout the year.

I will now turn the call back over to Russ.

Russell Becker: Thanks, Kevin. As you’ve heard, APi delivered record financial results in the second quarter and the first half of the year. The business continues to perform well, and we continue to deliver on our commitments. I’m confident in our leaders’ ability to generate continued momentum in the business, build on historically strong execution and consistently drive margin expansion in any macro environment — any macroeconomic environment through increasing high-margin inspection, service and monitoring revenue, pricing initiatives, operational improvements and their relentless focus on customer and project selection. As reflected in the increased guidance Kevin just went through, we had strong momentum across our global platform.

Backlog remains healthy. And as planned, we’ll continue to focus on the right work for the right customers in the right markets. We believe we can create sustainable shareholder value by focusing on our 13/60/80 long-term value creation targets. As a reminder, these include above-market organic growth and adjusted EBITDA margin of 13%-plus by 2025. As we look to 2024 and beyond, we have great confidence in the business and the direction we’re heading. With that, I would now like to turn the call back over to the operator and open the call for Q&A.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from Jon Tanwanteng of CJS Securities.

Jonathan Tanwanteng: Hi, good morning. Thank you for taking my questions. My first one, just on the increased guidance. How much of that is contribution from acquisitions that you made recently and any changes in FX? Any color on that would be helpful.

Kevin Krumm: Jon, I heard the first part of the question, so I’ll answer that. And the second part, you’ll have to come back to me on. So our most recent acquisitions announced as part of our July lease are in our guidance. The impact of that in the back half of the year from an EBITDA standpoint is at or around a couple million dollars.

Jonathan Tanwanteng: That’s great. I was wondering about FX contribution as well?

Kevin Krumm: FX contribution?

Jonathan Tanwanteng: Yes, if any.

Kevin Krumm: FX in the back half of the year at EBITDA will be somewhere approximately $2 million to $4 million at current currency expectations.

Jonathan Tanwanteng: Okay. Great. And then just I’m looking at a little bit longer term, can you talk about the M&A pipeline that you’re seeing even with the smaller tuck-ins that you’ve been doing? Are you seeing more opportunities out there? And is there an opportunity for anything that might be a larger, or more accelerated as you look at the pipeline? Thank you.

Russell Becker: Thanks, Jon, and thank you for your continued interest in the company. Our M&A pipeline remains really robust. And as we’ve shared in the past, and we’ve been focused on North America primarily in the U.S. in the Life Safety space just partly because we see the same opportunities available to us in our international business. But we remain focused on executing on our value capture program in that part of our business. But the pipeline is really robust. And I think our company leaders do a really good job of helping us build that pipeline along our M&A leadership inside the company. But there’s plenty of opportunities, and we continue to look forward to pursuing them and making sure that we add the right businesses to the APi family.

On these bolt-on acquisitions, the number one criteria for us is to find the right fit, make sure we’re culturally aligned and we share common values. And when we do that, that’s one of the, I think, one of the primary benefits we have as we think about why we’re able to acquire these companies at reasonable purchase prices, etcetera. So lots of opportunities for us. Excited for what the rest of the year is going to bring and potentially in the next year.

Jonathan Tanwanteng: Great. Thank you guys.

Operator: Your next question comes from Julian Mitchell of Barclays.

Kiran Patel-O’Connor: This is Kiran Patel-O’Connor on for Julian. I just wanted to ask on Life Safety. The organic growth there in the quarter and the first half was pretty strong. So I was just curious how much of that organic growth that you’ve seen year-to-date is market-related versus market share gains? Thanks.

Kevin Krumm: Hi Kiran, this is Kevin. I would say that the lion’s share of the growth that we’re seeing in the U.S. Life Safety business is share gains. We continue to win business through our inspection-first model that continues to feed them the service side of the business. But we’re going out there and taking business and competition, and that’s the primary driver.

Kiran Patel-O’Connor: Got it. That’s helpful. And the market share gains are — I know you talked about the market being very fragmented. Is it really smaller players that you’re taking it from? Or are there larger competitors that you’re getting these market share gains from?

Russell Becker: I mean, I think it’s probably a little bit of both when you think about it. And the key driver for us there is the continued build-out and growth of our inspection sales team. And as we continue to build that group out, we will continue to take share. As I mentioned in my remarks, the more traditional way of companies capturing service and inspection work is to do the installation work first. And when the installation work is basically 90% complete, they try to approach that customer and sell them on a service and inspection contract. And we’ve put that model on here and are really, really focused on calling on the already built environment. And that sales force is out pounding the pavement, building relationships with potential customers. And so you’re taking that share away from whether that’s a large player or a small player. And it’s about having a different approach and a different tactic as we go after that business.

Kiran Patel-O’Connor: Got it. Thank you. And then just my follow-up would be you talked about strategic pricing initiatives. And I was just curious, where are these focused and if you’re getting any pushback from customers on them and if there’s any churn as a result? Thank you.

Russell Becker: So I mean, number one, we basically, especially in our inspection and service contracts, we build in price escalation. That is typically timed with the price escalation associated with our — with the wage rate and labor increases that come along with it. So we’re actively building that price increase into these contracts as we’re out selling and pitching. We have some situations — and I would say in general, I would say that these price increases have been very, very sticky. We have had some attrition; some of this attrition has been on purpose. I would say more of that potentially in the international business. And if you go all the way back to last November to the Investor Day that we had in New York and Andrew White made his presentation, he showed 5% customer attrition that basically we plan for.

Some of that would come through price increases because we had poor performing contracts that we needed to deal with the pricing on. We haven’t seen 5% customer attrition. It’s been probably 2% to 3%, something like that. But in general, our price increases have been sticky.

Kiran Patel-O’Connor: Great. Thank you.

Operator: Your next question comes from Kathryn Thompson of Thompson Research Group.

Brian Biros: Hey good morning. This is actually Brian Biros on for Kathryn. Thank you for taking my questions. To start on the — I think contract revenue was called out at high single digits in the quarter, some part of the business, but I don’t think I’ve heard you talk about that much. Can you just talk about trends in kind of that part of the business? Can we expect solid performance like that going forward? Or is this more of a onetime event in the quarter?

Kevin Krumm: Good morning, Brian. Our contract revenue in the quarter was up organically, but it did not grow at the same pace on the service side. Our contract revenue, just to clarify, was at around mid-to-low single-digit growth in the quarter.