APi Group Corporation (APG) Earnings Call Transcript & Summary

Good afternoon, everyone, again. This is Andy Kaplowitz, U.S. Sector Head of Industrials, here at Citi Group. We're really excited to have APi Group with us today. Jim Lillie, who is the Chairman of APi; and Russ Becker, who is the CEO of APi. And this is a great story. This is a company that basically, through acquisition, has grown into over $3 billion in annual sales, good margin expansion opportunity, strong end markets. We like the life safety business. So I'm going to turn it over to Russ for some introductory remarks, but then we're going to get right into fireside chat. Most of you know the drill, we will do Q&A from investors. [Operator Instructions] So with that, Russ, over to you, and thanks for joining us.

Yes. Thanks, Andy. Appreciate it, and we appreciate all of you participating in the conference today in the fireside chat and taking interest in the company. It really is a great company. Also joining Jim and I today are Tom Lydon, our CFO; and Olivia Walton, our Vice President of Investor Relations. So I'm going to take about 5 minutes and give you an overview of the company and the services that we provide, and then we'll open it up for questions. APi is a market leader in business services in the Safety, Specialty and Industrial Services sector. We provide statutorily-mandated and other contracted services to a strong base of long-standing customers. We have over 200 locations worldwide. Primarily, we are in North America. We do have an expanding footprint and platform with the recent acquisition of SK FireSafety Group. SK is roughly $145 million provider of life safety services that's based in Benelux. They also have office locations in Scandinavia. Our footprint allows us to maintain close relationships with local decision-makers while also having the ability to execute for our national-based customers. We support margin growth by leveraging our scale and -- to benefit from procurement savings resulting from enhanced purchasing power. The culture of the company can really be summarized in our core purpose of building great leaders. We started a journey of leadership development in 2003. We were roughly a $600 million, 3% business at that time. And we believe that the investment that we've made in all 15,000 of our team members as leaders has benefited the shareholders of this company. It's -- we are very much a people-centered business and individual growth, both personally and professionally, is very important to our long-term success. Maybe some comments on each particular segment. Safety Services is our largest segment. We're the #1 provider of fire protection and life safety services in North America. We had approximately $1.8 billion in adjusted net revenues in 2019. We love the end markets that we serve, high tech, health care, data centers, very robust end markets that have thrived through the course of the pandemic. Our #1 priority in this segment is to grow inspection and service revenue. We have a unique go-to-market strategy of selling the inspection work first. We have a developed -- are in the process of developing a sales force that allows us to continue to grow our inspection revenues. We know that we are going to generate some place between $3 and $4 of service work for every dollar of inspection revenue that we generate. We also believe that if we execute well on our inspection and service work that we're going to create a much stickier relationship with our customers that allows us to negotiate and participate in higher-margin project-related work to support their expansion needs. Really, the key part of the inspection work is the statutory nature of it. The local and regional codes and laws require that our customers' facilities are inspected at least annually, and in some cases, it's twice a year, it could even be quarterly. And that's a beautiful thing for our business and one of the things that allowed us to continue to drive through the pandemic. Inspection and service currently represents about 40% of our revenue. We have an established goal that we want at least 50% of our revenue coming from inspection and service. And when we achieve that, we'll actually move the goal close to 60%, and we'll keep growing from there. Our average project size in the segment is $10,000. So very quick hitting and quick turning projects. Specialty Services segment generated approximately $1.5 billion in adjusted net revenues in 2019. We have great customers in this space. We find the work that we do there to be acyclical in nature. We are working for private utilities, public utilities, 5G technology companies. Our customers have very robust capital programs. We have great visibility into those capital programs that allows us to plan our work. And we like being right next to them. It helps, for sure, when we try to get paid. Our average project size is $60,000 in the segment. Our Industrial Services segment is our smallest segment. We completed the divestiture of 2 businesses in 2020. Going forward, it will be less than 10% of our total revenue. We are focused on the service side of the transmission industry. That -- in that segment, we have been very purposeful in focusing on margin improvement, and we are doing that through a very disciplined approach to customer selection and project selection. This is an asset-light business. CapEx typically runs some place around $50 million or $55 million. Because of the pandemic, we spent less than that in 2020. It's a variable cost business. It allows us to flex up and down very quickly based on the demands that our customers have. We have a consistent record of organic growth and margin improvement. We also have a strong history of accretive M&A. And since 2005, we successfully completed over 60 acquisitions. We believe that the markets we operate are highly fragmented, creating many opportunities for us to continue to grow the company through M&A. We approach M&A really through 2 separate lenses. You can look at it from the traditional APi lens, which are typically smaller, anywhere from $2 million to $25 million tuck-in type acquisitions that we're able to do at a lower multiple, some place typically in the 4 to 6x range. We're also working with the Mariposa team, specifically, Martin and Jim, to opportunistically pursue larger, more transformational acquisitions. We will always be opportunistic. The alignment of cultures, values and fit is something that's very important to us. We like businesses that are similar to ours with a high history of strong free cash flow generation. We look for businesses that have strong, experienced leadership teams. And services, services, services, something that's very, very important to us. Our pipeline is strong and robust. We have a number of really good opportunities that we're looking at. So before I turn it over to Andy for Q&A, I just want to give a couple of 2020 preliminary year-end highlights is, if you saw our press release from Monday afternoon, adjusted net revenues will be -- for 2020 will be approximately $3.5 billion. Adjusted EBITDA will be at the mid to higher end of the increased guidance range of $370 million to $380 million provided on December 9. We are cautiously optimistic about the opportunities in front of us, but we're still being realistic in dealing with some challenges with COVID-19. Excluding the strategic decline in Industrial Services, we expect growth in organic net revenues of approximately 7% in Safety Services and 8% -- or excuse me, combined 7%, 8% in Safety Services and 6% in Specialty Services, excuse me. Our balance sheet is very strong. We finished the year with roughly $515 million in cash on the balance sheet. With the forced exercise of the warrants, we anticipate bringing in another $245 million. We should have close to $0.75 billion of cash in the balance sheet that we can put to work as we move forward into the year. Lastly, we have indicated that we are planning on holding an Investor Day, most likely at some point in the second quarter, to highlight our trading discount from a free cash flow multiple perspective, earnings and multiple expansion opportunity in addition to discussion about the company and certain key strategic initiatives as we focus on top line growth in our core business, supplemental M&A and margin expansion. So with that, Andy, I'll turn it back to you.

Russ, that's great. Very much appreciated. So let me start out by just asking you about sort of the guidance you put out. And obviously, you talked about guiding to the mid to high end of the 2020 range, which is great. If you think about '21 in that sort of 7% growth, visibility to sort of get there, like what are you baking in for the primary end markets that you're in? Is this service-driven that's driving your sort of 8% growth, I think you have, for life safety? How are you thinking about '21? And I know you'll give us more detail when you report it. But to the extent that you want to talk about sort of what's baked into the outlook, I think that would be helpful.

Yes. For sure. So like as we move into -- we're into 2021, and we look into -- as we walked into this year, there was really 2 kind of key barometers that gave us good confidence in the guidance that we've provided. First was, if you recall, at the end of the third quarter, we had reported that our inspection revenues had grown by 6% through Q3. And that is actually short of our goal, but we felt that was very positive with everything COVID-19-related. So it's our hope, actually, that as we finish tying out our numbers for the year that we're actually going to be able to report a slightly better result than that. So we are able to continue to grow inspections in the middle of the pandemic, which is very positive, and we continue to build out that sales force, which we believe is going to lead to further growth. The other aspect of it is, is that we walked into the year with our backlog being slightly higher, plus or minus $100 million than it was at the beginning of 2020. And we like the quality of that backlog. Again, I think that goes back to my earlier comment about the end markets that we serve, and we really feel good about the end markets that we serve. And so the quality of the backlog is there. So we feel very good about where the business is at and where the business is really trending towards in this fiscal year.

So Russ, the virus spiked for a while there for a couple of months in calendar Q4 and early in sort of Q1, but it seems to be, again, a little bit better now. Have you seen any sort of difference in site access? Would you say that site access is getting better? Is it stagnant? Is it getting worse? Like what would you say about that?

I would start by ranking site access and saying that Europe is probably the most difficult to -- from an access perspective, they're locked down much more, I guess, severely than us. Then I would go to Canada, and then I'd move to the U.S., which -- and then in the U.S., you're planning with a bunch of different sets of rules and regulations. So our people, I think, are dealing with it better, Andy, than we did, say, maybe in the earlier months. I think people are just -- they're just dealing with it. And where we still see the impacts is when we'll have a, I guess, mini burst of our own in one of our offices. And then also next thing you know, you've got 10-day quarantines and you've got 10 service techs that have to quarantine for 10 days because they were exposed by one person or something like that. But that's all on a one-off basis. And so I think that just creates a little bit of choppiness as we continue to move forward and something that we continue to watch. Most likely, everybody's crystal ball probably is somewhat similar, but we think that it's going to be into the summer before the vaccinations have had enough of an impact where you can actually start really saying that you feel like it's behind you.

And Russ, when you think about margin, and maybe this is for Tom, I don't know. But when you think about margin for '21, you have a little bit of a tough comparison versus '20 in the sense that temporary costs maybe come back a little. At the same time, I'm sure you can flex that a little. So it's hard because we don't know the pieces. But when I look at sort of what you gave us as sort of an end game for '21, it does seem like there's a little bit of margin expansion in the segments. I mean ex Industrial Services, which I'll ask you next, but in terms of your 2 main segments, is that the way to think about it? A little bit of margin expansion expected. You can flex temporary costs a little bit. And the margin expansion has to deal with rise in inspections over time, and then we know you're doing back-office type stuff as well.

Yes. Well, there's a lot of ground to cover there, to be sure. And so I mean, there's a number of levers that we need to continue to pull, but you look at it from a cost perspective. And other than some of the actual true pruning that we've done, most of the cost reductions and those types of things where we froze 401(k) and Tom and I didn't take a salary for some period of time and so on, those cost reductions have come back into the business and are just part of our regular budget and everything that we're planning on as we move forward. But when we look at margin expansion, we feel that -- number one, I feel that our margin expansion goal of 12% EBITDA by 2023 is totally realistic. And once we achieve that objective, we are going to tell you what the next objective is, but we are going to continue to focus on driving margin expansion in the business. We're going to do that in a number of ways. Obviously, improving our mix and continuing towards that 50% service goal is a big part of it. Through really disciplined customer selection and project selection, we need to continue to focus on reducing our loss rate. We made really good progress on it this year. We didn't quite get to our goal from what I can see, but we've made good progress on it. We need to take another step forward this year. You alluded to it, we have 2 efforts going on in our, what we call, business process transformation, which is really tying technology with improved business processes. As an example, we are preparing to start rolling out a Ceridian payroll platform across the entire portfolio of our business, which will allow us to move to a true shared services model and ultimately reduce costs by leveraging our SG&A. We're also -- I allude -- I made a very short remark to this in my opening address, but we are working on increasing visibility from a procurements perspective so that we can really truly start to leverage our scale and take cost out of the business. Strategic M&A is going to play a big part of it. We need to make sure that our M&A activities are accretive to that margin expansion goal. We've got an opportunity with pricing and being more disciplined around how we're pricing our work and our services. And then lastly, I would just tell you, we have an opportunity to just flat out be better. And we need to continue to focus on the execution in our companies and in our businesses just to drive a better result. So it's a really -- it's a number of different levers. It's not one single bullet.

And Russ, you mentioned steel. So I'd be remiss if I didn't ask you about how inflation impacts the company. In other words, you don't make anything, you're a services business. So maybe there's an opportunity there. But how should we think about, given it seems like all of a sudden inflation environment, at least on the materials side, how that would impact APi?

Yes. So when you think about it, like Specialty Services and Industrial Services, we buy very little material. I mean most of our customers provide the material, and the risk is going to be -- that inflationary risk is going to be associated with their work. In our other businesses, if you think about it, Safety Services, the average project size is $10,000. So the quick-hitting nature of the work and the services that we provide for our customers, there's very little long-term risk from a commodity perspective. And while I say all of that stuff, I don't -- we have been communicating and talking to our business leaders nonstop since we've seen some of these inflationary jumps in commodity prices to make sure that they're protecting themselves in their proposals and their proposals are only valid for X amount of days so that you can adjust if you have to because you had a 9% pipe price increase or something like that. And so we're constantly talking to our businesses. Our procurement leader here at APi is constantly putting out notifications on where our vendors see pricing going. So we've been able to stay in front of it and protect the business, I think, pretty well.

Great. And I would say the only thing that sort of mildly surprised us about your guidance was that Industrial Services business decline of 30% on the revenue side. And again, I know you're managing it, Russ, but like, I guess, I'm just surprised by the magnitude of that. So like what are you keeping and what are you just sort of getting out of? Because you already divested a couple of businesses, right? So like I thought that was out. But so there just must be other stuff that you're sort of getting out of.

Well, so I would share 2 points of reference. First of all, 30% sounds like a big number, but in the scheme of APi, it's about $125 million. So it's not a huge overarching figure. Second is that we are being super disciplined in customer selection and project selection and not focusing on top line. If you recall, going back to as far as 2019, the margins were suppressed there partly because of the assets we held for sale, but partly because we had -- we were too focused on top line versus bottom line. And so we are just zeroed in on project selection and customer selection. And lastly, what I'd leave you with, Andy, is that we're focused on mix, and we want to change our mix from project-related activities to the service side of the transmission industry. And the gross margins are better. The opportunities are there. The maintenance budgets for the transmission players are very, very big and robust, and we see a better opportunity there. So as you go through that, that's what you're seeing in that mix is us purposefully driving to the services side of the space.

So Russ, I mean, there seems to be a bit of a secret sauce to growth at APi. And what I mean by that is, over a long period of time, you've grown at that 7% number. And you talk about sort of share gains. I don't know if you bake in share gains for '21 or not. But maybe talk about how you're getting consistent share gains because I think that's a very important thing to sort of highlight for you guys.

It's, without question, is our inspection sales first, and that is a true differentiator for us and for the business. And as our companies, so to speak, had drank that Kool-Aid and as we've really started to build out that sales force, it's really truly making a difference. And by growing inspections, we are growing service right alongside of it, and that's growing our mix in the right direction, and that's what's going to change the needle. And our business is highly fragment, the space, in general, is highly fragmented. And so for a small family-owned business, say, in Minneapolis, where we are, it's easier for that company to go chase a $700,000 project versus chasing around $700,000 of revenue, $10,000 at a time like our average project sizes. And so as we've been at this and marching to this drum for a longer period of time, we are, so to speak, getting that flywheel turning, and that's what's ultimately going to continue to make the difference in the business. And I really think that our approach of selling that inspection first and building out that sales force is what's going to continue to make the difference and allow us to take share. We're also looking at different things, Andy, like increasing the wallet with our individual customers. As an example, when we bought SK Fire life safety, they provide services to defibrillators and things like that. We didn't do that here in the U.S. And so now we are implementing a process where we're going to start offering our customers the ability to service their defibrillators, and we're offering monitoring services. And so we are continuing to increase the types of services that we can provide to our customers, which is really a great opportunity for us.

And Russ, the other big-picture question I get, the concern is around, obviously, the U.S. nonresidential construction market, right? So maybe we can demystify a little bit is how much of the company really is exposed to sort of new dodge starts, if you may? And sort of talk about the exposure you have as we enter 2021 here. Where are you in that?

Yes. So I would tell you that we really like the end markets that we serve. And the end markets that we serve have shown their resilience through COVID, just like we feel like our business has shown that resiliency. So data centers, high tech, health care, 5G. Some of our public utility customers have these robust natural gas distribution retrofit programs. I mean all of these programs in these end markets have continued to provide ample opportunity for the company as we've worked our way through pandemic, and that's not slowing down. Now the developer-led 250000-square-foot commercial office building in Downtown Portland that's not going to be built because of everything that's happened in the country over the last year, it's not going to happen. But for us, the good thing is, is that we wouldn't have been doing the life safety work on that 250000-square-foot building anyways. We're going to be too consumed with building our business with Intel or with Google or whoever else it may or may not be.

So Russ, is it fair to say that the percentage of, the example that you gave of that office building, is actually relatively small nowadays versus the data center? Like any sort of help you could give us with the -- I guess, the newer-type exposure versus the more traditional-type exposure, just out of curiosity.

I don't have that data or that figure. I mean it's just not -- that's just not a market that we've played well in just in general, Andy. I mean developer-led projects are price-driven projects. And anytime that price is going to be the primary selection factor, we're not going to play well in that space. And so we just avoid this space. Now does that mean that we don't do some of that? Of course, there's -- it's a very small percentage of the work and the offerings that we have. But in general, we just don't play in that space. We need to be choosing customers that are going to select us because of the value that we bring, more complicated, where our engineering services are required and those types of things. And that's why the Facebooks of the world and Apples of the world are really good customers of ours.

Andy, if -- It's Jim. If I could put it a different way, it's so small, we don't track it.

I like that. That's a good way to put it. So -- well, we do have an investor question here, so I'll just read it. What must or is happening in the sales team to have more disciplined and better customer as well as project selection?

Yes. So we've developed a rigorous go, no-go process that we put our businesses through. And anything that is over $4 million in size comes across my desk. And the initial reaction people might have is that, "Geez, you could be a bottlenecker, how do you manage that?" I take you back to our average project size of being $10,000 in Safety and $60,000 in Specialty, there's not that many of them that come through. Even if it's a master service agreement that's going to total more than $4 million, it has to come across my desk. And primarily what you -- what I'm looking for anyways is who's the customer. Because very -- it's not very often that the type of service that we're proposing on is something that we're not competent to deliver. It's who's the customer. Are we going to get paid? What's our track record? And I'd like to remind people that I'm not very old when I make this comment and -- because I don't think I'm very old. But I've been doing this for a long time, and so I have a very good internal radar on who to stay away from, who could be a risk and that's -- we're looking at it. But we -- it's -- basically, it's in like app form, so our people can have it on their devices, and they can go through the exercise of filling it out. And if they -- as they go through it, oftentimes, they make their own decisions that it's not the right opportunity for them to pursue. So just being more disciplined around that and using our process that we've put into place.

Russ, you mentioned SK. So maybe just a quick update on how it's doing as it's entered your portfolio. You talk about Europe still being a little tough on sort of site access side. But SK, obviously, is very complementary to your existing business, building out your European coverage. So talk about sort of early going, how it's going.

Yes. I think it's going quite well. To be honest, Andy, we did -- we executed the transaction 100% digitally, I mean. And that was a first for us just because of the difficulties of trying to travel. We are actually able to find a location that the individual that runs the business for us, and I could meet without having the quarantine for 14 days on either side. And so we actually traveled to Aruba and spent 3 days together and going through a number of different things. And it was just -- it was time -- it was awesome. And we just had a great dialogue. We really created alignment on what we're going to try to accomplish with the business, and I feel I just am very optimistic about what this is going to look like as we continue to go forward. If you recall, the business, it's not that big. It's about $145 million in revenue. It's right down the center of the fairway for us as it relates to the fire life safety space. They've already drank the service Kool-Aid. 50% of their revenue is coming from services already, which is positive. And then they had a nice history of tuck-in acquisition work themselves. So everything about that, coupled with the leadership team, really bodes well, and we feel really good about it and about the future. We already have a couple of small tuck-ins that we're working on, and we're digging in on right now. The European market is, to some degree, is more fragmented than the U.S. market, and we think that, that creates additional opportunity for us.