APi Group Corporation (NYSE:APG) Q4 2022 Earnings Call Transcript

APi Group Corporation (NYSE:APG) Q4 2022 Earnings Call Transcript February 28, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the APi Group’s Fourth Quarter 2022 Financial Results Conference Call. . I will now turn the call over to Olivia Walton, Vice President of Investor Relations at APi Group. Please go ahead.

Olivia Walton: Thank you. Good morning, everyone, and thank you for joining our fourth quarter 2022 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, February 28, and we have no obligation to update any forward-looking statement we may make. As a reminder, we have posted a presentation detailing our fourth 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. The reconciliation of and other information regarding these items can be found in our press release and on our presentation. It is now my pleasure to turn the call over to Martin.

Martin Franklin: Thank you, Olivia, and good morning, everyone. 2022 was another incredible year in the development of APi. Following the acquisition of Chubb in January of 2022, we became the world’s leading life Safety and Security Services provider. We created a business that is focused on statutorily mandated services that benefits from recurring revenue with 26,000 team members operating in over 20 countries. APi has a truly global platform for our customers and is well positioned to continue — for continued growth and margin expansion, providing fully integrated seamless service to multinational corporations on a worldwide basis. 2022 marks a year of record net revenues, record adjusted EBITDA and record adjusted diluted earnings per share.

We are pleased with the execution and leadership across APi to build on our already solid foundation for a very bright future. As many of you know, we held an investor event on November 17 to provide a thorough walk-through of Chubb as well as our continued path of deleveraging swiftly to our targeted range of 2 to 2.5x net debt to adjusted EBITDA, and our continued focus on thoughtful incremental M&A. We believe we are well positioned for continued organic growth and margin expansion and that we have the appropriate strategy and action plans in place to achieve our target 2025 levels with a healthy runway for continued growth beyond 2025. With that, I will hand the call over to Russ. Thank you.

Russell Becker: Thank you, Martin, and good morning, everyone. Thank you for taking the time to join our call this morning. Before we provide you with a summary of our record results for 2022 and solid outlook for 2023, I would like to start by thanking those of you that joined us for our investor update event in November and last week in Miami at the Barclays and Citi conferences. Based on the feedback received in November and again last week, we believe that investors have a clear understanding of the strategy we have to make the most of the opportunities in front of us and achieve our goals as we continue to focus on shareholder value creation. As you’ve heard me say on prior calls, the safety, health and well-being of each of our team members remains our #1 priority.

We remain grateful for their hard work and effort. This focus and other foundational priorities provides a platform from which we can continue to enhance shareholder value. 2022 was a year of record financial results for APi. We delivered strong organic growth, adjusted EPS and free cash flow growth in a challenging macro environment. We believe this once again demonstrates the stability of our recurring revenue services-focused business model and the ongoing execution of our strategy by our talented team members. Key specific highlights for the year ended December 31, 2022, include the following. First, net revenues increased on an organic basis by 12.2%, driven by a double-digit increase in inspection, service and monitoring revenue in our legacy business.

We achieved our goal of growing inspection revenue 10% plus and continue to drive towards our goal of 60% plus of total net revenues coming from inspection, service and monitoring. As a reminder, on average, inspection and service revenue generates approximately 10% higher gross margin than contract revenue, and monitoring revenue generates approximately 20% higher gross margin than contract revenue. Second, adjusted gross margin grew by 288 basis points to 26.8%. We are pleased with the execution and leadership across our businesses to offset margin pressures through pricing activities; focused growth in inspection, service and monitoring; strong spend controls; procurement initiatives; and disciplined project and customer selection. Third, adjusted diluted earnings per share increased by 29.1% or $0.30, driven by strong operational performance and accretion from the acquisition of Chubb.

Fourth, adjusted free cash flow of $412 million representing an 84.8% increase compared to the prior year period. In summary, the business continues to perform well and delivers on its commitments, driven by strong organic growth and solid operational performance as well as our ability to mitigate margin pressures that exist on a macro basis. Chubb continues to perform in line with our expectations. We’ve had more positive than negative surprises, and most importantly, what we have found has only reinforced our excitement about the acquisition. Compared to a 5-year CAGR of 0% before our ownership, Chubb delivered solid organic growth in 2022 despite COVID-19 supply chain disruptions, inflation and a difficult macro environment. As planned, we completed the work of transitioning Chubb from — we completed the work of transitioning Chubb from services provided by its prior owner by year-end 2022.

This involved a tremendous amount of work and significant process improvements, and we are grateful for the hard work across our teams. The integration is occurring swiftly. Savings are significant, and we continue to be energized by the opportunities in front of us as the world’s leading life Safety and Security services provider. As outlined at our investor update in November, we see a clear path to a 2025 run rate value capture opportunities of at least $100 million. Our enhanced platform is already driving wallet share gains with overlap customers, and we are excited about the opportunities to expand cross-selling of services offerings. As we look ahead, we are focused on continuing our efforts to build a global and coordinated inspection sales force to drive our go-to-market strategy of selling inspection work first, which we believe will lead to further service revenue growth and ultimately drive margin expansion.

We entered 2023 with positive momentum on many fronts. Our backlog remains strong and was up approximately 9% as of December 2022 compared to the end of December 2021. We remain focused on being disciplined on project and customer selection, and we’ll continue to focus our efforts on growing acyclical recurring service revenue aspects of our portfolio rather than growing for the sake of growth and risking profitability. While some parts of the world are under recession and others may enter a recession, we believe that the statutorily driven demand for our services and the diversity of the end markets we serve provide predictable recurring revenue opportunities and help to build a protective moat around the business. As part of our annual budgeting process, each of our operating companies presents a long-term strategic plan.

In addition, we challenged each of our operating companies to prepare a downturn plan that addresses any potential challenges unique to their market and operations. We are confident that our business leaders are prepared, not only on paper through our downturn plans but also to take definitive and early action if needed. Whatever the challenge, we intend to build on our successes over the last 3 years to achieve the goals we have set for ourselves over the next 3 years. We are confident in the resiliency, growth prospects and strong free cash flow generation of our business and remain focused on capitalizing on opportunities in front of us, while maintaining a conservative balance sheet and liquidity profile. Our balance sheet is strong, which provides us the flexibility to pursue attractive capital allocation, including M&A.

We believe that the markets in which we operate are highly fragmented, and we are keeping a close eye on the opportunity set. We have an extensive pipeline of potential bolt-on opportunities for life Safety and Security services businesses. I would now like to hand the call over to Kevin to discuss our financial results and outlook in more detail. Kevin?

Kevin Krumm: Thanks, Russ. Good morning, everyone. I’ll begin my remarks by reviewing our consolidated results and segment-level operating performance for the fourth quarter and full year before turning to our outlook. Reported net revenues for the 3 months ended December 31, 2022 increased by 53.1% to $1.7 billion compared to $1.1 billion in the prior year period. This was driven by revenue from acquisitions completed in Safety Services. Net revenues increased on an organic basis by approximately 6%, driven by strong organic growth in Safety Services. Consistent with prior quarters, approximately 2/3 of this growth was driven by price and pass-through of material and labor costs and 1/3 was driven by volume, which we measure through labor hours.

For the year ended December 31, 2022, reported net revenues increased by 66.4% to $6.6 billion compared to $3.9 billion in the prior year period, driven by revenue from acquisitions completed in Safety Services. Net revenues increased on an organic basis by 12.2%, driven by double-digit growth in inspection, service and monitoring revenue for our legacy businesses and Safety Services. Approximately 2/3 of this growth was driven by price and pass-through of material and labor costs and 1/3 was driven by volume. Adjusted gross margin for the 3 months ended December 31, 2022, was 27.8%, representing a 319-basis-point increase compared to the prior year period, driven by acquisitions in Safety Services and an improved mix of inspection service and monitoring revenue.

For the year ended December 31, 2022, adjusted gross margin was 26.8%, representing a 288-basis-point increase compared to the prior year, primarily driven by reasons provided in the review of the fourth quarter. Adjusted EBITDA margin for the 3 months ended December 31, 2022, was 10.7%, representing a 40-basis-point increase compared to the prior year, driven by an improved mix of inspection, service and monitoring revenue and leverage on higher volumes in Safety Services. For the year ended December 31, 2022, adjusted EBITDA margin was 10.3%, consistent with prior year adjusted EBITDA margin of 10.3%. Margins were negatively impacted by supply chain disruptions, inflation and mix from completed acquisitions, offset by an improved mix in inspection, service and monitoring revenue and leverage on higher volumes.

Adjusted diluted earnings per share for the fourth quarter was $0.36, representing a $0.07 increase compared to the prior year period. The increase was driven by strong organic growth in Safety Services and accretion from acquisitions. For the year ended December 31, 2022, adjusted diluted earnings per share was $1.33, representing a $0.30 increase from the prior year period driven by accretion from acquisitions and strong organic growth in Safety Services and Specialty Services. I will now discuss our results in more detail for Safety Services. For the 3 months ended December 31, 2022, Safety Services reported net revenues increased by 111% to $1.2 billion compared to $569 million in the prior year period, driven by revenue from completed acquisitions and strong organic growth.

Net revenues increased on an organic basis by 18.1% compared to the prior year period driven by a double-digit increase in inspection service and monitoring revenue. For the year ended December 31, 2022, Safety Services reported net revenues increased by 120% to $4.6 billion compared to $2.1 billion in the prior year period, and net revenues increased on an organic basis by 17.1%, driven by reasons provided in review of the fourth quarter. Adjusted gross margins for the 3 months ended December 31, 2022 was 32.4%, representing a 146-basis-point increase compared to prior year, driven by the impact of completed acquisitions, pricing initiatives and disciplined projects and customer selection. For the year ended December 31, 2022, adjusted gross margin was 31.3% compared to the prior year adjusted gross margin of 31.5%, driven by inflation and certain supply chain disruptions, which caused the decline in productivity.

This was offset by an improved mix in inspection service and monitoring revenue, pricing initiatives and the impact of completed acquisitions. Adjusted EBITDA margin for the 3 months ended December 31, 2022, was 13.2% compared to prior year adjusted EBITDA margin of 13.5%, primarily — driven primarily by SG&A mix impacts from completed acquisitions. For the year ended December 31, 2022, adjusted EBITDA margin was 12.2% compared to prior year adjusted EBITDA margin of 14%, driven by SG&A mix impacts from completed acquisitions and the reasons provided in review of gross margins. I will now discuss our results in more detail for Specialty Services segment. Specialty Services reported net revenues for the 3 months ended December 31, 2022 declined by 8.9% to $510 million compared to $560 million in the prior year period, driven by timing of projects at our specialty contracting businesses and a robust sales performance in Q4 2021.

For the year ended December 31, 2022, Specialty Services reported net revenues increase by 6.4% to $2 billion compared to $1.9 billion in the prior year period, driven by an increase in service revenue, increased demand at our infrastructure, utility and fabrication businesses and improved capture of inflationary-driven price and cost pass-through. Adjusted gross margin for the 3 months ended December 31, 2022, was 16.7% representing an 83-basis-point decline compared with the prior year, primarily driven by margin declines, which are arose due to inflationary cost pressures and productivity constraints on select jobs. This was offset by an improved mix of service revenue and improved productivity. For the year ended December 31, 2022, adjusted gross margin was 16.2%, representing a 100-basis-point increase compared to the prior year, driven by improved productivity and improved mix of service revenue.

These factors were offset by inflation and supply chain disruptions, which caused downward pressure on margins. Adjusted EBITDA margin for the 3 months ended December 31, 2022, was 10.4%, representing a 139-basis-point decline compared to the prior year due to the reasons provided in the review of gross margins. For the year ended December 31, 2022, adjusted EBITDA margin was 10.3%, representing a 12-basis-point increase compared to prior year due to the leverage of higher volumes. Turning to cash flow. As expected and consistent with historical trends, we saw a strong sequential free cash flow performance in Q4 relative to Q3. For the 3 months ended December 31, 2022, adjusted free cash flow was $230 million, above our previously guided range of $190 million to $210 million and representing an $84 million increase compared to the prior year period.

This increase was driven by the positive contribution from acquisitions, continued focus on working capital discipline and strong EBITDA growth in our legacy businesses. For the year ended December 31, 2022, adjusted free cash flow was $412 million, and our adjusted free cash flow conversion was approximately 61%. As of December 31, 2022, our net debt to adjusted EBITDA ratio was 3.1x and the weighted average maturity of our debt was over 5 years with the earliest maturity in 2026. As part of our 2023 deleveraging plan, we paid down $200 million of long-term debt in January of this year. We remain laser-focused on cash generation and deleveraging at approximately 1 turn annually as we move towards our stated long-term target of 2 to 2.5x, which we expect to achieve near year-end 2023.

I will now discuss our outlook for 2023. As we look ahead to 2023, we are confident that our relentless focus on growing statutorily required higher-margin inspection service and monitoring revenue combined with our robust backlog and variable cost structure positions us well to prosper even if the macro environment continues to be volatile. As stated in our February 21 press release, we believe that net revenues for 2023 will range between $6.8 billion to $6.95 billion, representing growth in net revenues on an organic basis, in line with our historical performance. We expect Q1 net revenues to be $1.54 billion to $1.56 billion. Based on current exchange rates, FX will remain a headwind in Q1. So this guidance represents a Q1 organic growth of 6% to 8% on a constant currency basis.

For 2023, adjusted EBITDA, we expect to deliver $735 million to $775 million on strong margin expansion. We remain confident in achieving our goal of 13% plus adjusted EBITDA margin by 2025 through an improved mix in inspection, service and monitoring revenue; procurement savings; value capture opportunities; and leveraging our global scale. We expect Q1 adjusted EBITDA to be $135 million to $145 million, which represents organic growth of 8% to 16% on a constant currency basis. We estimate that we will recognize between $55 million to $65 million of restructuring costs related to the Chubb restructuring program in 2023. Not only will these restructuring actions help the bottom line, but they will also significantly reduce organizational complexity, making it easier for the team to service customers and focus on driving organic growth and mix.

Depending on how interest rates move through the year, we anticipate interest expense to be approximately $150 million for 2023 and between $35 million and $40 million for Q1. We expect depreciation for 2023 to be approximately $85 million and capital expenditures to be approximately $95 million. Our adjusted effective tax rate remains approximately 24%, and we expect our adjusted diluted weighted average share count for 2023 to be approximately 273 million. We expect to arrive at an adjusted free cash flow conversion for 2023 at or above 65%. For Q1, we expect adjusted free cash flow conversion to be flat, which is consistent with prior years and in line with the seasonality of our cash flows. I’ll now turn the call over to Jim.

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Q&A Session

James Lillie: Thanks, Kevin. Good morning, everybody. APi’s continued strong performance in the fourth quarter was the culmination of what was another outstanding year for APi in 2022. The double-digit growth in organic net revenues combined with the acquisition and continued integration of Chubb, the development of a robust multiyear improvement plan for that business and the company’s ability to offset natural headwinds allowed APi to again produce record earnings and generate substantial free cash flow. As reflected in the guidance we gave last week for 2023, we have strong momentum balanced across our global platform. Our leaders continue to build on historically strong execution, continue to mitigate macro challenges and are staying focused on operational excellence.

As you have heard all of us, we have great confidence in the business and the direction we’re heading. We will continue to remain agile, focused and adaptive as needed to create sustainable shareholder value by focusing on long-term value creation targets. These include solid organic growth, targeted adjusted free cash flow conversion of 80%, adjusted EBITDA margins of 13% by 2025 and targeted net leverage ratio of 2 to 2.5x, which, as Kevin mentioned, we expect to achieve near year-end 2023, supplemented by our recent $200 million reduction in term loan debt. Everyone is excited about the opportunities in the year ahead and our ability to execute on our strategic plan. I’d now like to turn the call back over to Russ and the operator for Q&A.

Operator: . We’ll take a question from Kathryn Thompson of Thompson Research Group.

Kathryn Thompson: Just in terms of your outlook, if you could give a little bit more color in what pricing is looking like for 2023, given services won’t have an obvious material inflation backdrop, and also, you’re just seeing some rationalization in certain categories of pricing across the value chain, be whether it raw materials and in some cases, labor. Really being able to give a little bit more detail of that 2/3 growth for price and 1/3 from volume or labor hours?

Russell Becker: Kathryn, thanks for taking the time to join our call this morning. Well, there’s quite a bit there in your question. I would start by saying that we — I feel like the business has done a very good job of taking price through a very difficult inflationary period. And we feel that the price that we’ve been able to take thus far is sticky and sustainable in the business as we march forward into 2023. We’re still seeing inflation in the business. I mean, in past calls, we’ve talked about how we really watch hot-rolled coil closely just because we buy so much pipe. And we’ve seen — we saw a dramatic decrease in pricing over the, say, the latter half of 2022. But over the course of the last 3 months, we’ve seen pipe prices pick up again.

And — so we continue to monitor that, and we continue to focus our businesses on taking price where — taking prices appropriate. We want to make sure that we’re fair with our customers, but we want to make sure we continue to take price. Especially in North America, when you think about our labor force being primarily union. And there’s a number of — we feel there’s a number of advantages for us to be union, one of them is stability and visibility into our labor cost. Typically, our union agreements from a wage escalation perspective reset in the spring, usually right around April 1. That is a very natural time for us to adjust our pricing and to take price with our customers, both on the labor and the material side of the business. So I think Kevin in his remarks said that approximately — of our organic growth, approximately 2/3 of it came from price, 1/3 of it came from volume on the inspection and service side.