APi Group Corporation (APG) Earnings Call Transcript & Summary

Next session, it's my pleasure to have here APi Group. CFO, Kevin Krumm, Adam Fee in Investor Relations. So thanks very much, Kevin and Adam, for being here.

I think first question, perhaps and I'll just talk about recurring service is something that's been a big focus for APi Group since the IPO. You have that target of kind of 60%-plus share of recurring service. I guess a couple of things on that point. One is it's a term we hear from many companies here that means slightly different things to different people. So what's APi's definition? And then what's the kind of strategy to get that share of the total recurring business up?

Yes, sure. First, thanks for the invite. We appreciate being here. Appreciate your support. Yes, you said since the IPO, the thing I would say is really the service and growing service as a percent of our overall revenue for APi Group has really been a core focus since the last financial crisis. Going into that financial crisis, APi Group probably had 15% of the revenue was service and about 85% was projects. And obviously, going through that period of time, Russ and the leadership team realized, the service business is a better business to hold up through cycles. And so really since then, they've been on a mission to continue to improve that mix. At the time of the Chubb transaction, so early 2022, and the close of Chubb that moved that mix that they moved from probably 15% back then to close to 40% in 2021. That mix now moved up to 50%. How they've been able to grow that or how we've been able to grow that over that period of time was largely investing in our inspection-first go-to-market model. And that's unique for APi Group. So we go to market by selling statutorily required inspections first. For every inspection dollar that we generate, we generally generate $3 to $4 of service. And so when we talk about service, we're talking about inspections, service and monitoring. And so we made a significant investment in that through that period of time and now we have a sales force that's going out and selling those inspections. And so if you look at our performance 2020 till now, we've been able to grow inspections at a double-digit clip every quarter except for Q2 2020, which, of course, was the launch of the pandemic. And so that growth has allowed for pull-through service growth in the high single digits and/or double digits every quarter. So that flywheel, if you will, is working really well for us right now. It's allowing our service business to continue to perform collectively globally in the high single digits. It's allowing us to be, therefore, really selective on the project work we do. And so as we go forward here, we see our service business continuing to grow at that clip, projects business probably less. And so over time, that mix is going to continue to improve as -- so it's early 2022, we're about 50%. We'll disclose it here coming up, but we obviously moved the needle on that as well, and we continue to do it through that equation.

Got it. And how does the sort of -- within the project side of things, there's that deemphasis there then there's sort of another element of kind of general pruning of types of customer perhaps as well. So maybe when you think about that pruning side and also project management or selectivity, where are we on that? What's the sort of scale of revenue headwind, if it's possible to quantify kind of this year or next few years?

Yes. So we really started the project pruning in earnest late 2022, early 2023. We started it -- or the focus was 3 areas. One was internationally, where we spent time in the Chubb business across their customer contract portfolio and realized there was areas and instances where we just needed to get out some of those contracts. We -- also HVAC and Specialty on the project side of the business. And in those businesses, as we exited 2022, which was a period of, obviously, supply chain disruption and inflation, but also robust demand in those end markets. We saw it as a great opportunity to continue to be really smart about where we spend our project hours and really try to pivot more and more of those hours to service and the hours that we were producing on the project side of the business to do it for the right customers in the right end markets with the right programs. And so over that period of time, so late 2022 or early 2023, we've been focused on doing that. I expect we will lap most of that work in the first half of this year. And so what you'll see in the back half of this year will be improved growth rates on the project side of the business in HVAC and Specialty.

Got it. And how do you assess sort of within those -- HVAC, I guess, is sort of easier to understand because it's a discrete kind of collection of products and assets, but the sort of competitive landscape in HVAC, specifically, how you're thinking about sort of what you can do versus the traditional OEMs in that space? And then Specialty, I guess, by definition, it's a collection of different things. Any 1 or 2 areas within Specialty you'd highlight as this is what APi is really good at?

Well, on the HVAC side, I would say that our service offering continues to grow well. It differentiates us in the markets we're in. We have invested there too on service. And our inspection model actually on the HVAC business is something in recent years we've invested in, and we've seen good growth. And so while inspections aren't necessarily statutorily required in that space, they're largely required because you don't want to be in a situation where your HVAC system breaks down, whether it's really cold or really warm. And so we've seen an investment behind that. So we've seen good growth in that business. And again, we think that differentiates us versus our competitors and/or OEMs in that space because the same success that we've had with that on the life safety side of the business, leading with the pull-through service revenue, differentiates us in the marketplace, allows us to be really selective on the project side is a flywheel, we think, and we're seeing benefit on in the HVAC business as well. On the Specialty side, I think your question was what areas in those businesses that we're excited about?

Yes.

Well, I would highlight we have a Specialty -- group of Specialty contracting businesses. They'll do installation work, roofing work, heat trace works and things like that. And a lot of that, too, is service related and/or smaller projects work. And we've really seen those businesses continue to grow really well through this bland cycle that we're in. And so we're excited about the growth and the margin prospects in those businesses as we go forward.

Perfect. And then I guess a couple of other areas that investors kind of talk a lot about the growth opportunity more broadly is data center and power grid. What's the sort of growth rate there for the company? And any sense of kind of percent of sales or scale of APi's exposure to DC and power grid?

Yes. So from a data center perspective, it's less than 10% of our sales, but it's -- we've taken a meaningful step forward growing the business there. We haven't disclosed the growth rate by end market, but it's definitely punching above the overall company growth rate pretty significantly. In the data center, we expect demand to continue to be strong just as demand for data through AI and all the new technological advances that are coming on the market. I know that some of our customers have spending plans kind of going up end of this decade that will drive growth and opportunity for us. And not only on the safety services side, where we're installing and servicing the fire protection equipment, but our fabrication business on the specialty services side is also taking part in the build-out of these data centers throughout the country. Then on the electrical kind of the specialty side, I think the electrical grid upgrade is another area we feel excited about. It's a pretty substantial amount of funding in the IIJA for that, over $70 billion to upgrade the electrical grid to essentially support the electrification of cars and other technology. And we are -- we haven't seen that funding to hit the market yet, but that's -- we believe that will provide ample opportunity over the next few years.

Perfect. And more broadly on sort of IIJA or Inflation Reduction Act. Have you seen across APi, not just in the grid business, but have you seen much of a tailwinds already? And do you expect much of an extra tailwind in future? Or are we kind of in the run rate now from those 2?

So I think it's actually at a similar stage as the electrical grid funding that I just mentioned, where our leaders in that business are seeing -- beginning to see more proposal activity, and I think that will accelerate in 2024, but they don't expect a real impact on the financials until 2025 and beyond. It seems like this type of funding always moves a little slower than everyone hopes and expects, but that seems to be where our team leaders are seeing it right now.

Fantastic. And I think share gain is definitely something that's apparent. I guess it will take one of your sort of more traditional competitors like SimplexGrinnell, for example. What do you think it is for APG that helps it take share consistently, greater focus or reinvestment? What's the -- some of the elements?

I mean for sure, our largest driver there is a driver we talked about it earlier in the discussion, which is our inspections business, that differentiates us in the marketplace. The investment we've made in that business over the last decade is significant and it's bearing fruit. What's really important when you're going to market and you're doing inspections and the follow-on service work is that you're there on time, and you can get the deficiency report turned around quickly such that you become the easy button for your customers. And if you think about that, just to be there on time, it's a highly integrated offering. So you are oftentimes working with local engineer who's managing those facilities. You're with him or her all day. And so showing up on time today matters a lot. And being the easy button for them matters a lot, which is being able to turn the deficiency report around in 48 hours and then being able to schedule the follow-on work quickly thereafter. And that takes a lot of back-office infrastructure routing, servicing and training. And so we've invested in this space. It's how our inspection business, though the result of that has been the double-digit growth that we're seeing. And yes, you pointed to it, a lot of that comes from share gain because that inspection market is not growing as fast as we are.

Yes. Perfect. And then geographically, I guess, up until sort of 3, 4 years ago, very, very domestic-centric business at APi. That changed a lot, particularly with Chubb, but a couple of other acquisitions as well in recent years. What's the sort of satisfaction and how those non-U.S. assets are being managed? How do we think about kind of profitability levels domestically versus international?

So I think we should probably just talk about Chubb in house [indiscernible] on that one. So the thesis on the Chubb transaction was, we believed it to be an under-managed, somewhat overlooked asset inside of UTC and then carrier. However, it was a branch-based service business, and we have a long, long history of acquiring and, I'll say, improving and/or fixing branch-based service businesses. And so the thesis was this is a big transaction, but it's largely center of the fairway. As we've got into the business and now had it with us for the better part of 2 years, I would say things are going as we expected in our original thought process. We've gone in. We've introduced those group of businesses to our leadership approach and our culture, which, as you know, is real intangible. Inside the company, we invest heavily behind it. We brought our leadership programs into that business with very high appreciation and satisfaction from the leaders in that business. They're frankly really excited to continue to pull that into their businesses, so we could expand that. Took the first year really to get the right set of leaders in place, which is done as of sort of early 2023. So excited about the leadership team we have in place. Our idea as we went through this was we're going to tackle the cost first and quickly and work on the commercial model sort of as we do it. The commercial model being making sure that we're going to market with inspections and service sales first and following with project business. So the conversion of that has gone well. You saw simply, I guess, [indiscernible] overall. Now you capture target from $100 million to $125 million, which is largely a credit to the leadership team that we had in place. They kind of had their first lap around the track and identified additional opportunity to get after, I'll say, cost savings in that business, largely back office and operational and functional efficiency. And so that has been increased, and we feel good about that number. And largely, the business, which came to us that 9% EBITDA margins in at least a 5-year period, I believe, of no growth has been organically every year since we've had it inside the APi Group and EBITDA margins that were at 9% that we committed to getting to 15%-plus by 2025, I guess you could think of that as sort of a linear progression. We've been on that line so far today, sort of 2 years in. So it's gone well, and we feel good about it.

Okay. That's a very good summary. And the sort of how much geographic sort of heavy lifting was there within Chubb? Exit certain countries, bulk up exposure and others, kind of where are we on that process kind of figuring out, okay, this market is strong, has a good local team, let's put a lot more into X; some other market, let's just pull out it's not worth the energy and time?

I would say we have largely not pulled out of any market. There's 1 small country in Southeast Asia, where there was a very limited presence that we decided it didn't make sense to be there. Would be the only place I'd speak to the fact that we pulled out of. I would say we remain excited about the markets they're in, especially when you think about sort of Western Europe, which is where the largest piece of their density is. Our organic -- sorry, our growth algorithm, which is 1 part organic, 1 part inorganic, is an algorithm we're excited about bringing into that business, too. Now we have 125 million reasons to get the initial work done first. But when you think about that model, we've already sort of ramped up their organic profile, and we're seeing organic growth in that business. And when we get that platform right, primarily in Western Europe, we see it as a really fantastic opportunity to bring our inorganic model to it, which for those not familiar with the story, is we're the largest player in the markets we're in, but we largely have 5% of the market. So it's highly fragmented and there's a significant opportunity continue to do inorganic growth through bolt-on tuck-in M&A. At that point, you're effectively buying these businesses and sort of dumping gas into the tank, right? And we see Western Europe and that platform in Western Europe in the market because it's highly fragmented is a great opportunity to bring that equation to that business. So we're excited about that.

And just on the kind of cyclical point, which we haven't really talked much about that, but there was a sort of an update to numbers that you provided earlier in the week, so that there is that out there in public. But I guess, even could of said, European construction hasn't been particularly healthy since you bought Chubb. As you said that your own business, the growth is accelerating somehow. So there's that acyclical element that may be investors still sort of figuring out. What are some of the levers there? There's some share gain, I suppose; there's a statutory aspect in certain industries...

There's pricing, right? So just pricing discipline and continuing to drive that discipline into that business, margin expansive pricing on the service side of the business is a discipline that our businesses have had for many, many years. It's a discipline that we're going to lean on for many years going forward, almost regardless of what's going on from an inflationary standpoint. It's an approach we brought into that business, too. So pricing has, I'll say, improved significantly sort of under our leadership versus prior ownership or leadership. And then you talked about it, yes, I mean it's the service element of that business is, we'll stand up like the legacy APi business under almost any condition. And we've continued to invest in the service side of the business, and we continue to see good, consistent growth and performance on that side of the business as well.

And on the sort of total margin front, moving on to that, you've got that 13%-plus sort of target for 2025 on EBITDA. What's the sort of confidence level in hitting that? And I guess if we think about the sort of margin differential of projects versus recurring, where are we on that today?

So first, on the 13%, it's a number we still have out there, so you can expect that we still feel good about hitting it. And I think if you look to sort of at least the information we released this week, both on approximately where we closed 2023 and approximately where we're guiding to 2024, you can see that we made sequential good steps forward really since 2021. So we feel good about that number. And the thing I'd like to highlight at this point, as we get closer and closer to 2025, is that is not an end state. It is certainly the beginning, its first phase. And as we get into 2025, we'll have a higher target because we believe our portfolio of businesses continue to -- can continue and will continue to move north of that. Your question on service versus projects. I'll say we've seen good margin expansion on both sides of those businesses in both of those offerings. I would say almost equivalent. The service business through pricing; continuing to sell inspections, which come to us at a higher margin than sort of the service fleet have allowed us to expand margins on that side of the business. On the project side, the disciplined project selection that we've had and some of the deflationary impacts of the pass-through that we were doing in 2022 have allowed margins to expand there. I mean we've talked about the margin differential in this business, which I think is a question you asked. It's probably the same. And it's been about what we see on the collective service side of the business, we make 10 percentage margin point plus higher on that business than we do on the project side of the business.

That's helpful. And as you said pricing is kind of critical in a service- or labor-intensive business model such as APi's, how -- the ability, you think, say, in this year, wage inflation seems pretty sticky, as materials inflation has eased. What's the confidence in kind of offsetting inflation pressures on wages with pricing?

Yes. So I think you talked about the dynamic world. I'll just reaffirm that really, we've seen material costs subside. We've seen wages in our business continue to sort of go up. Now what I would say around that is it's not extraordinary to what we've seen over the last decade. About 50% of our workforce is under a collective bargaining agreement. And so that gives you good predictability as you go forward. A lot of these agreements are 3 to 5 years. In the U.S. Obviously, that's the union structure. We have great relationships with our unions in the U.S. We have great visibility to those escalations and they're not, I would say, above -- significantly above sort of where they've been historically. We talked about a pricing muscle that we've had historically, and we feel good about our ability to continue to price through that. The 1 thing I would highlight is whenever we talk about cost -- wage cost, et cetera, the one thing I'd like to highlight is one of the most expensive areas that you have when you think about wages is turnover. And so we've invested $30 million over the last 5 years in our leadership programs. Those programs aren't pointed at Adam and I, they're pointed out our men and women in the field who are going out every day and doing service work. So whether the union or nonunion, it's an element that differentiates us in the marketplace. It's an element that our employees love that allows them to continue to grow and develop. And it's an element that's allowed us to have well below industry average attrition rates -- I almost said retention rate -- attrition rates. And so that, too, is a huge factor when you think about cost of employees and cost of employees year in and year out.

And overall, thinking about the margin rates, you said understandably 13%-plus is not a ceiling. So when you think about sort of overall operating leverage with service being a high or recurring revenue being a higher share of the total. Are those sort of in the 20s? Is that kind of the aspiration for drop-through from revenue into EBITDA?

I mean, is this an incremental question? Or is this...

Incremental margins.

No, 20s is the right area. Over the last 12 months, we came in right around 30%, but that's obviously been accelerated a bit by some of our pruning and some of the Chubb value capture, but we still feel like longer term, we can be punching above 20% on the incremental side. For all of the reasons you said, as we grow the Safety Services business and add more revenue to our branches there under the same cost structure, you're going to gain that operating leverage. And even at the corporate level, we've been, since the Chubb transaction, building out a global corporate functioning and capability, and that investment is largely complete, and we'll start to kind of get operating leverage on that going forward.

Perfect. And then maybe sort of cash flow and balance sheet optionality. Sort of cash flow is, without going down at rabbit hole, there's always -- there's some adjustments to it. Sort of how do we think about the free cash flow sort of cleaning up in terms of conversion rate to EBITDA? And I guess the M&A outlook, kind of how do you characterize your sort of pipeline right now and the ambition to kind of get back on to meaningful M&A this year?

Okay. So I'll hit those sequentially. So on the cash flow side, our target is 80%. Today, we guide to an adjusted free cash flow number. Those adjustments are largely there because of the work we're doing on the Chubb transaction and the platform work that has resulted from the Chubb transaction. We've talked about those adjustments. Our goal right now would be that those adjustments subside as the Chubb program subsides. And so that 2025 is when we should be through those adjustments. And coming out of there, that target will remain the same at 80%, so whether you're talking adjusted or unadjusted. I do like to highlight that the target is -- it's not something we're going to hit every single year, right, because the free cash flow and your growth matters a lot. And so years where we flex up to maybe 10%, you're going to see a lower number. But that 80% based on the assumptions we have is something that we think we can bounce around once we get to that point. I think in 2021, we were at 55%; 2022, given what some of the stuff we saw on supply chain and investing in working capital, we moved to 60%. This year, our target of 60 -- 2023, our target was 65%. We talked or we announced that we beat that number. And as we go into 2024, I can tell you, we're going to take another step towards that 80% number, and working capital rate is going to be a piece of it. As we moved and continue to improve, it's allowed us to delever on the clip that we said we would. We ended the year inside of 2.5x. Over the last 12 months, approximately, we've spent $100 million on M&A. So we took 12 to 18 months off. Over the last 12 months, we've reinvested in those programs. It's largely in the bolt-on space is where we're going to continue to focus. As we go forward, you should expect, over the next 12 months, a meaningful increase there. We were able to keep our pipelines robust and warm as we went through that delevering cycle, and so we remain excited about what we see there. And we think that those smaller bolt-on tuck-in is going to be our sweet spot as we move forward here because it presents a really great opportunity to add significant value to the business and to our shareholders.

Got it. And last one, sort of on that smaller bolt-on's point. So the smaller deals, you're generally disciplined historically, so the multiples on that should be what in that sort of...

4 to 6, 4 to 7. They haven't moved much over the last 2 to 3 years.

Great. Well, I think now we'll switch quickly to the audience response survey questions, please. So grab those gray devices. First question. Do you currently own the stock. Generally, not much. Second question. Really around sort of general bias to APi Group right now. Very positive. Third -- that's encouraging. Third one is earnings growth for APi versus the multi-industry, let's say, peer average sort of medium term. Slightly above peers. Next question is on usage of excess cash. So generally, bolt-ons preferred. Next question around valuation, sort of year 1 PE. So mid-teens-ish is sort of placeholder. And then the last question on sort of share price headwind, why don't people own more of the stock? Mostly poor growth, question mark. Fantastic. Well, thanks so much, Kevin and Adam for being here. Thank you.

I really appreciate it. Thank you.

Thanks very much.