APi Group Corporation (APG) Earnings Call Transcript & Summary

Russ Becker, President and Chief Executive Officer of APi Group and Jim Lillie, Co-Chair. Thanks very much, both of you for being here.

Maybe just -- you issued a sort of a trading update, if you like, yesterday morning. It sounds like the year ended on a good note, revenue, earnings, cash flow. So maybe just sort of flesh out a little bit sort of how you saw the quarter and where we are on, say, supply chain that you seem to have managed well based on the cash flow.

Well, there's a lot there, Julian. And -- but yes, I mean, obviously, in the press release yesterday, we stated that we are going to be in the high-end range of our guidance on both, from a revenue and an EBITDA perspective. Our leverage ratio will be down below 3.3 -- with a clear path to get it to 2.5 by year-end. So things have been positive. The business continues to be in a really good place. As we move into the new year, our backlog remains really solid. We continue to grow inspections at a double-digit clip which is really one of the key bellwethers for us as we continue to move the business forward. So it's been good. Supply chain. I mean, I guess one of the things about us is that we don't look at supply chain, we don't look at inflation. We never looked at the pandemic like it was an excuse for us to not deliver on our commitments. And so we've just been super focused on running the business and controlling what we can control. We're still experiencing some supply chain issues, mostly due to a number of the components that we purchased like fire alarm panels and those types of things. Pipe prices, which have -- was a big concern for us at one point a year ago from a price escalation perspective, pipe prices have come down. But they've recently started to inch back up. And so we're continuing to keep a watch on that. Demand remains really strong. But I think our people, in general, have done a really good job of managing it. The short duration, average project size and safety services is less than $5,000. So it creates a more nimble kind of business climate and for us to -- that enables us to really manage, I think, inflation in supply chain issues more efficiently.

Got it. And as you said, backlog is a topic that's come up in a lot of conversations, mostly in the hardware context for companies that historically had no backlog. For you, it is part of your daily business kind of pre-COVID as well. So how do you see that pace of sort of backlog build? What kind of visibility does it give you? What do sort of the margins look like in the backlog versus what's in the P&L today?

Well, I mean, number one, I don't know that I think backlog is the -- I get concerned for the first time we really published what our backlog was because I don't want people to necessarily grade us whether our backlog is slightly up or slightly down. I actually would like to see our backlog contract a little bit, which would show me that we're being more disciplined from a project selection perspective as we really take a -- not that we haven't been focused on it, but we're maniacal in our focus on gross margin. And if we want to achieve our margin expansion goals, we need to be. So our backlog, we typically burn backlog Q3, Q4, we rebuild Q1, Q2. I suspect that we won't have any problem sustaining our backlog at the levels that we're at. And the quality of that backlog as inflation continues to subside, the quality of that backlog will continue to be better and better and better. So I'm optimistic about where we're at as we're in the new year. Visibility really through the course of the year is strong and good, and the pipeline remains full. So in general, that's positive for us.

And how do we think about kind of cyclicality of the business. Resi has been softening in the U.S. for a year now. Historically, there's some transmission to non-res starting with the private sector and then spreading after that. Do you see any signs of that resi weakness sort of bleeding into some of the commercial customer base or not at all and the regulatory element means if you do see it, it's a long way from today?

Well, I think typically, the industry in general is a lagger so it's going to lag what's going on in residential space. We have basically zero exposure in the residential space, so that's a positive for us. We monitor the Architectural Billings Index and some of those types of things more to just keep an eye on what's happening in the industry. It doesn't have a great effect on our business if the ABI is at 49 or 52. And you are seeing like multifamily projects slip out to the right, mostly because of higher interest rates and the projects don't -- the performance for those projects aren't penciling out anymore. You're seeing developer-led type projects slip out to the right as well because of rising interest rates. The good part for us is we were not involved with a lot of that type of project-related work because it's so price sensitive and that's just not the world that we want to play in. And the reality of it is, I think I said here last year, and I said end markets matter. And I like the end markets that we play in, data center, semiconductor, health care, higher education. I think really the heavy industrial space, those end markets continue to be strong and they were strong through COVID. They were strong through the last couple of years, and the outlook remains really, really good. So.

That's helpful. And I think some companies here or a lot of those with any exposure to Inflation Reduction Act and some of those domestic stimulus measures. We hear a lot about it. For you, it's not discussed as much. But just given our geographic mix and the customer base, there should be some impact. So how do you think about that in terms of, say, timing and how big of a driver could that be for your business?

Well, regarding the federal legislation, there's a couple of things that would have more of a direct impact on our business, like the rural broadband act and it is a fund real broadband that will have a positive effect on pieces of our business. It's not a huge piece of our business. I think less than 5% of our total revenue comes from telecom type activities. The semiconductor act, obviously, we are fortunate that like Intel is one of our very good customers and the semiconductor act is going to help us. And then as it relates to the infrastructure bill, the way I like to put context around that as it relates to APi is -- a rising tide floats all boats. And that, in general, the infrastructure bill will help the industry in general, even though we probably won't participate in a lot of the project-related work that gets funded through it. Our competitors and our peers will take advantage of that, which will create more space for us with our existing customers and with potentially new customers to take share and hopefully increase pricing and ultimately increase margins because there's -- our competitors are going to go elsewhere.

Yes. that makes sense. And as you said, a lot of your business is obviously dealing with an existing installed base of utility networks or telecom or building infrastructure. What's the sort of lag, I guess, when a new building comes up when you start to get meaningful revenue from?

Well, I mean, number one, it depends on the size of the building, right? And if it's a massive facility and a massive structure, it's going to take a while for the new build to be completed. One of the things that we consistently as we try to tell and articulate our story is that, number one, we're an inspection first driven -- and we have an inspection first driven mindset because the inspections on a facility like this for the life safety system are required by law. They have to happen. And that we've got historical data that shows that we're going to generate some place between $3 and $4 worth of service work off of every dollar of inspection revenue that we generate. And I think that, that's something that's really important. Now if this building were brand new and we were doing the inspections on this building, you're not going to get $3 or $4 worth of service work off it because it's brand new. You might get $1 or $2 worth of service work, whereas a building that's 20 years old, if you're doing the inspections there, you might get $5 or $6 with the service work. So the actual new construction side of it as it relates to inspection and service isn't necessarily where your revenue is going to come. For us, I mentioned in my -- kind of my opening salvo that inspections continues to grow at a double-digit pace, which is so important for us because we want to continue to grow inspection service and monitoring as a percentage of our overarching revenue is 60%. We're at 50% today. As I sat here a year ago, that was our goal. And we're there. We've moved the goalpost to 60% and now we're driving to that mark. And so it's really important. It's a really important kind of strategic component to the business and where our focus is at.

Got it. And when we think sort of nearer term about some of the pressures on the business, you talked about some supply issues or maybe fire control panels, that type of thing. How quickly are those sorts of supply headwinds easing for you? I mean is there any difference regionally now that you have Chubb.

Well, Chubb is really suffering from the same supply chain-related issues as we are. I mean Chubb is not a manufacturing business. They have 1 proprietary product that they manufacture, which is really specific to their French business. And so they're in the marketplace just like we are. Now there was a relationship with Edwards on the fire alarm side when it was Carrier -- Edwards is a Carrier company and that stayed with Carrier at the time of the transaction. And so we do some business with them, but we're continuing to look -- I think we feel that being product agnostic in our business, which means that we buy from Honeywell, their NOTIFIER product or FCI or Gamewell, we buy from Siemens, we buy it from Edwards. So we've got more flexibility in our business model. I think that's an advantage for us. We're not beholden to one product so that as our installed base continues to grow, and also that relationship maybe isn't as enjoyable as it once was, we've got more flexibility to pivot if we need to pivot. And I think that's a key part of it. Our business is 100% focused on services.

Got it. [ Let's talk ] about the utilities vertical. It seems that sort of spending there historically was low growth, the last couple of years has been pretty good growth. Do you see that -- sort of sustainable or you think it's kind of a catch-up that will fade?

Well, I think it's sustainable. I mean if you look at the area that we focus on with the utilities is natural gas distribution centers, potable water distribution center systems. These systems have been in the ground for decades, and they're basically corroded, deteriorated, worn out. And I don't see how the spend will ever slow down. The best part for the utilities is they're incented to spend the money because they get to put it in the rate base and start getting it paid for from their customers. And you also have really good visibility into their capital programs. So you can see it, you can plan for it. You know what's coming, what's down the pipe, you need to pivot, you can pivot. So it's really -- it's -- there's plenty of really good opportunities in the space.

And then away from the top line maybe on the cost base, I mean I think labor and payroll is 40% of COGS, almost 2/3 to 3/4 of OpEx. Wage inflation is something every company is feeling right now, understandably. How are you kind of managing that? What's the transmission mechanism to sort of push that on to the customer?

Well, especially in North America, the majority of our field workforce, the men and women that are doing the work in field are union by nature, right? The advantage for us -- and we're -- we think being union in general, is an advantage for us. And we get skilled craftspeople. We have clear visibility into their wages and what their wage rates are going to be even through these inflationary periods in some of the contracts that have come up and expired and had to be renegotiated. The union has been very, very reasonable in their demands and their requests. And so we haven't had any work stoppages, which is a positive. And typically, the way it works is that union contract comes up someplace around April 1 every year, might be May 1. And that is a natural time for us to address our pricing with our customers. So you almost -- the way our businesses are structured, you almost have this annual natural time that's like, okay, I got to update my price. Okay. I've got to update my price. Okay. I've got to update my price. Now when inflation was raging, we had to be more aggressive. Now labor wasn't really escalating for us because it's constant because of that union agreement. But your products are the pricing there, fuel surcharges, those types of things, we had to be more assertive and more aggressive in making sure that we're taking price adequately.

Got it. And then as we think about Chubb, you haven't sort of -- we'll wait for the full results, I guess, for more details specifically, but maybe give us a sense of what's the Chubb organic growth rate today? And I don't know if you could sort of flesh out what's dialed in for Chubb growth-wise in the new -- the guidance for the year ahead?

Yes. So basically, if you go back to the investor conference that we had in November in New York this past year, I guess I'd call your attention to a few data points. Number one, over the last 5 years, basically, Chubb's had a 0% CAGR. So the company hasn't grown for 5 years. We saw sequential growth in Q3 and Q4 which was obviously really positive for us and something that we felt really good about as we breathe new life into the business. We're projecting modest growth in 2023 in that 3% to 5% range inside Chubb. Some of that has to do -- if you remember, we provided a bridge, revenue bridge in that deck. And the last item that was on it was a reduction in revenue due to customer -- purposeful customer attrition as we work to eliminate some low-performing maintenance agreements that we have that are making little gross margin or maybe even losing a little bit of money. We need to move on from those customers. So we're optimistic that we can get Chubb growing at a reasonable rate. The expectation is that it gets to fleet average. For those of you who are familiar with the story, this company has historically grown at roughly 7% organically, and we have the same expectations for Chubb. And I guess the last point that I would make on this is that 2023 is going to be a year of kind of optimizing Chubb for us. It's my belief running this type of business for as long as I have, is that for us to really grow the business in a healthy fashion with healthy revenue with good customers, we have to get the business rightsized and optimized and we need to get back to that really, really solid foundation. So our focus is -- I mean, we're going to be focused on growing the business where we can -- don't get me wrong, but we need to get the business optimized as we move through the course of this year. And that's really a big part of our emphasis inside of Chubb today.

Got it. And on the synergy point, I think there's a $100 million opportunity. How much was realized last year? You've guided EBITDA for the year ahead. What's the sort of the synergy assumption within that?

Well, number 1 is basically people right? And in 2022, we took approximately $30 million of restructuring. We expect to take the lion's share of that 100 -- the rest of that $100 million during the course of this year, and we'll see some of that bleed into 2024, just because those of you that are familiar with Western Europe know that restructuring in certain countries such as France takes a little extra effort working through social plans and those types of things. So we're taking those issues on -- head on. But essentially, when you think about that $100 million, it's really people related, and that's where the optimization comes. It's real estate and branch optimization and closing some branches and closing some country-level headquarters and moving to different facilities. But at the end of the day, the lion's share of that cost is really people related.

And how is the sort of the customer attrition retention? I mean there's some sort of deliberate nonretention going on. It sounds like this year as you sort of -- adopt a sort of a firmer approach to who you service. Or those you want to keep, if you like, how has that played out since the transaction? Have you seen a sort of a spike in attrition rates? Or no, it's probably easier to have retention now the business is better run?

Well, number one, we have a long ways to go to for me to look at you and say that we're running the business as efficiently as we should be. We believe that leadership at the company -- well at the corporate level, but at the country level, and at the individual branch level is imperative if we're going to be successful in reaching our objectives. And so we've been super focused on making the leadership changes that we need to make. And when you get better leaders in, they have, they'll have a better grasp of which customers we should really work hard on keeping on and which ones we should, so to speak, help phase out. Our -- we have had like -- we've had some customers that we've been really aggressive because we're really losing money to a certain degree on their service and maintenance accounts that we've actually gone in for double-digit price increases that have stuck. And I think that, that's positive. So we haven't seen an increase in customer attrition rates. And that's one of the -- it's positive, and we've been able to raise prices. And I think the price that we've been taking is sticky.

And on the overall sort of portfolio of Chubb, as you said, is the approach of, I suppose, stay in every region and pare off the customers in each region that are not good customers. Would there be a thought to sort of exit a region or sell some of Chubb or no, there's maybe down the road, but for now, there's a lot of opportunity to fix it first and then decide?

Yes. I think that -- I mean answering that question, I can answer that question, more on a macro perspective, Julian. Like everything is open for conversation. We've never been afraid to prune. We will prune, like we will shut down branches. We will evaluate whether there are certain countries and regions that we should or should not be in. And that conversation is ongoing, and we'll have that conversation as it relates to the core business as well. We need to look at what's best for the business, how we can optimize the profitability of the business and ultimately create shareholder value. And so we have really -- and Jim might have some thoughts that he'd like to share on this, but we have very active dialogue all the time with our Board about what's best for the company. And -- but we have it. We own it. We have to work on fixing it. And the better we get it to function, if we wanted to sell it, the better we have to do in the sale. Do you have anything you want to add?

No, I would just say, we bought it to own it. We didn't buy it to sell it. There's things that require some heavy lifting, some a little less heavy lifting to improve. And so there's tremendous opportunity for us to expand margins. We believe by expanding margins, we'll get multiple expansion, and you'll see that reflected in the stock price. So we're happy with the assets that we have at the moment and -- but we're -- at the end of the day, we're capitalists. So we'll do what's right to create shareholder value.

That's clear. And then it sounds early because it's only been 13 months since the deal closed, but looking -- people always in this sort of environment, are always looking for the next thing. Do we think about M&A?

I learned that really quickly.

So do you think about M&A -- next 2024, you can start to look at, I don't know, bolt-on, let's say, or what have you.

I think we have 2 perspectives. I can give you 1. If you look at the press release yesterday, we said debt to EBITDA was at least 3.3, if not better, and we'll give more color next week when we do the earnings. But we also said we expected to be at our targeted ratio of 2 to 2.5x near year-end '23. So clearly, there's opportunities. We wanted to step back from M&A last year as we digested Chubb, and we stayed laser-focused on that. But whether it be the historical tuck-in acquisitions that have done or something larger, as I said earlier, we're opportunists. So -- but we're actively looking at both tuck-ins and to be candid, there's nothing of size that's come our way that would cause a conversation. So I'd say tuck-ins are our focus. We've got room on the balance sheet because we also announced not only the 3.3 leverage but also we paid down $200 million of debt in January. So you know that number on an actual basis is lower. And so we believe that not only do we have debt capacity, but we have bandwidth capacity within the organization. Russ?

No. I mean same -- we kept our tuck-in M&A pipeline as warm as we could over the course of the last year. We've restarted those conversations and we expect to be active in the market during the course of this year. And like Jim said, we'll keep our eye open for bigger things and -- we have a lot of people that work -- really work their tails off to get the business separated from Carrier. And that's where our resources needed to be focused this last year. And I think that the investment community had their eye on us, and they wanted to see for themselves how we could execute on that and I feel like we delivered.

And I would just supplement all of that by saying the best opportunity is to buy back our own shares if the appropriate opportunity isn't out there in the marketplace. We like the management team. We think it's a good business, and it's a great value.

You just called me a manager. I'm not a manager, I'm a leader.

And very quickly, before we do the audience response, the free cash flow conversion, understandable pressures on it last year for a host of reasons shared by every company here. I didn't see much reference to that in the sort of wording yesterday morning. Do we expect free cash conversion to sort of move up reasonably this year ahead?

Yes, we will talk about that. We are making incremental progress on our free cash flow conversion. We expect to be able to deliver on our commitment. We've talked on average, it's 80%. and we plan to continue to honor that commitment. So we made -- we delivered on our guidance that we've provided for this year, you'll see an incremental improvement next year, and we'll share all of that with you next Tuesday when we release.

Perfect. We'll look forward to that. And now if we could move to the audience response. Survey please, if people could wield those gray devices again. Do you currently own the stock?

Yes, I do.

[indiscernible] to participate -- and then -- all right. So yes, 60%, no. Next question, your sort of bias, if you like, talk towards APi Group today. Okay. It's generally positive. The third question is around through-cycle earnings growth. And the peer set, every company is a little bit different here. I think we're still trying to use sort of broad multi-industry or U.S. industrials, if you like, is the peer set to think about. And most people think above-average earnings growth. Fourth question, it's around capital deployment -- short term or very short term, obviously, debt reduction is what you've been doing, but it sounds like there's room for more exciting things.

So we covered this in 30 seconds.

So people, smaller deals and buybacks, even though Chubb so far has gone very well. Next question, I think, is around valuation. So what PE multiple should be put on the sort of next 12 months earnings? There's a wide spread.

I say 6.

So mid-high teens, I suppose, as well it shakes out. The next question is around why is that mid-teens and not to Jim's point, over 21x on the target multiple like what's a single reason for that view on the valuation or why someone doesn't own the stock. And the most common answer is around organic growth, even [ back ] to your point sort of 7% historically? And then the penultimate question, I think the ultimate question rather, sorry, is around sort of ESG. Most companies, it's been about 30% for question 1 and 70% for question #3. So we'll see if it's different here. Okay. So some are at least thinking about it for APi at #4. So great. Well, thank you for participating. Thank you very much, Russ for coming and also, Jim, nice to see you, thanks again.