APi Group Corporation (NYSE:APG) Q1 2024 Earnings Call Transcript

APi Group Corporation (NYSE:APG) Q1 2024 Earnings Call Transcript May 3, 2024

APi Group Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, ladies and gentlemen, and welcome to APi Group First Quarter 2024 Financial Results Conference Call. [Operator Instructions] Please note, this call is being recorded. I will be standing by should you need any assistance. I will now turn the call over to Adam Fee, Vice President of Investor Relations at APi Group. Please go ahead.

Adam Fee: Thank you. Good morning, everyone, and thank you for joining our first quarter 2024 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, May 2, and we undertake no obligation to update any forward-looking statements that we may make except as required by law. As a reminder, we have posted a presentation detailing our first quarter financial performance and guidance for our second quarter and full year 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 our presentation. It’s now my pleasure to turn the call over to Russ.

Russ Becker: Thank you, Adam. Good morning, everyone. Thank you for taking the time to join our call this morning. Before we provide you with a summary of our first quarter results, I would like to thank our approximately 29,000 leaders for their unwavering commitment to APi. We remain grateful for their hard work and effort. We believe that taking care of our leaders results in our leaders taking care of our customers. This is one of the foundational principles by which we will continue to enhance shareholder value. Next week marks APi’s ninth straight year of celebrating Safety Week. As I’ve said before, the safety, health and well-being of each of our team members remains our number one value. Our commitment to safety drives industry-leading safety outcomes across the organization.

At the end of 2023, our total recordable incident rate, or TRIR, was below 1.0, which is significantly better than the industry average. We continue to strive for 0 incidents. We believe our leadership making APi a safer place to work along with the investment we make in each of our leaders’ development contributes to our low turnover relative to industry benchmarks. As we have said before, we remain relentlessly focused on our long-term 13/60/80 value-creation targets, which include the following: adjusted EBITDA margin of 13% or more in 2025; long-term organic revenue growth above the industry average; long-term revenues of 60% from inspection, service and monitoring; and finally, long-term adjusted free cash flow conversion of 80%. I routinely speak to our field leaders about how they can help us deliver on this strategy when I’m visiting our locations around the world.

Our leaders are aligned with what we want to achieve and how we intend to achieve it. Turning to the first quarter. In line with our 2024 plan, net revenues were essentially flat, driven by approximately 3% organic growth in service revenues, offset by divestitures, lower revenues from declining material cost pass-through and intentionally limiting organic growth in certain project-related revenues. Beginning last year and continuing into this year, we’ve continued our planned disciplined customer and project selection in our international HVAC and specialty businesses. Importantly, we achieved our goal of double-digit growth in core inspection revenues in our U.S. Life Safety business. This growth is key as we progress towards our long-term goal of 60% of our total net revenues coming from inspection, service and monitoring.

In line with our strategic initiatives, we continue to see strong improvements in adjusted gross margin for the quarter, up 390 basis points. The strong performance in gross margin led to record first quarter adjusted EBITDA margin of 10.9%, representing margin expansion of 180 basis points. The team continues to make meaningful progress executing our margin expansion initiatives and remains committed to building on that execution as we push towards our 13% or more adjusted EBITDA margin target in 2025. As a reminder, these initiatives include the following: pricing; improved inspection service and monitoring revenue mix; disciplined customer and project selection; Chubb value capture; procurement, systems and scale; accretive M&A and selective business pruning; and as I like to say, we can always just be better.

On April 15, we entered the complementary and adjacent elevator and escalator services market with the announced acquisition of Elevated Facilities Services Group for $570 million. We have long viewed the elevator and escalator service market as an attractive adjacency due to the highly recurring nature of the business, driven by nondiscretionary statutorily driven demand. Elevated is expected to contribute approximately $220 million in annualized revenues and approximately 20% adjusted EBITDA margins. We believe Elevated is an excellent platform opportunity for us to enter the $10 billion-plus U.S. elevator and escalator services market and execute our bolt-on M&A strategy at attractive multiples. We expect to build a $1 billion-plus elevator and escalator services platform over the long term through a combination of strong organic growth; a long-term cross-sell opportunity with our existing life safety businesses; and a robust M&A pipeline.

Elevated’s target market, elevator and escalator services benefits from continuous safety and regulatory requirements. It services an aging installed base with 55% of U.S. vertical transportation units being over 20 years old. Elevated also benefits from increased demand due to the growth of urbanization, declining durability and quality of elevators and modernization projects being driven by bringing aged elevators to code and compliance with safety requirements. The acquisition is expected to be immediately accretive to our 13/60/80 shareholder value-creation framework. Elevated’s strong organic growth, adjusted EBITDA margin profile of approximately 20%, 70% plus of revenue from inspections, service and repair and an asset-light business model driving strong adjusted free cash flow conversion is a great addition to APi. In summary, I can – I am sure you can tell, we are excited about Elevated.

It has many of the same attractive characteristics as APi and represents a continuation of our focus on building a robust line of businesses that provide mandatorily required life safety service. It benefits from its scale in a highly fragmented market. Its business is driven by regulatory demand and a loyal customer base. It is led by an experienced leadership team and a highly skilled workforce. I intentionally used the word leadership team instead of management team because at APi, we believe that leading and managing are fundamentally different, and we aim to build great leaders throughout the organization. Along those lines, Elevated, like APi, also maintains an unwavering focus on culture and developing its teammates throughout the organization.

We will update full year 2024 guidance to include expected results of Elevated following the close, which we expect to occur late this quarter. During the first quarter, we also closed on a small divestiture in our Specialty Services segment, which was expected to contribute approximately $20 million in annual revenue. Similar to the divestiture completed in the fourth quarter, this business was highly cyclical and largely focused on lower-margin project work in the energy sector. As we move forward, we remain focused on delivering both the 2024 plan our long-term 13/60/80 financial targets. We are excited about our robust pipeline of opportunities for life safety, security and elevator escalator services businesses and will continue to be thoughtful as we look for high-quality margin-accretive businesses and leaders to join the APi family.

I would now like to hand the call over to Kevin to discuss our first quarter financial results and guidance in more detail. Kevin?

Kevin Krumm: Thanks, Russ. Good morning, everyone. Reported revenues for the 3 months ended March 31, 2024, were essentially flat at $1.6 billion compared to $1.61 billion in the prior year period. Organic decline of 1.4% compared to organic growth of approximately 12% in Q1 2023 was driven by disciplined customer and project selection and lower revenues from declining material cost pass-through. The result of this was a 6% organic decline in project revenues. This was essentially offset by organic growth of 3% in services revenue. Adjusted gross margin for the 3 months ended March 31, 2024, grew to 30.7%, representing a 390 basis point increase compared to the prior year period, driven by price increases, outsized growth and higher margin services revenue as well as significant margin expansion in project revenues across both segments.

Adjusted EBITDA increased by 19% on a fixed currency basis for the 3 months ended March 31, 2024, with adjusted EBITDA margin coming in at 10.9%, representing a 180 basis point increase compared to the prior year period primarily due to the increase in adjusted gross margins, partially offset by growth investments and the investment in building our global capabilities and infrastructure. I am pleased to report that adjusted diluted earnings per share for the first quarter was $0.34 per share, representing a $0.09 per share or 36% increase compared to the prior year period. The increase was partially driven by strong margin expansion in both Safety and Specialty Services and decreased interest expense, partially offset by higher adjusted diluted weighted average shares outstanding.

I’ll now discuss our results in more detail for Safety Services. Safety Services reported revenues for the 3 months ended March 31, 2024, increased by 1.9% to $1.21 billion compared to $1.19 billion in the prior year period. Organic growth of 0.2% and compared to organic growth of 14% in Q1 2023 was driven by 4% growth in services led by double-digit core inspection revenue growth in our life safety and our U.S. life safety business and 6% organic growth in inspection services and monitoring and U.S. life safety. This was partially offset by an approximately 4% decline in organic revenue from project work, driven by planned customer attrition in our international businesses as well as disciplined customer and project selection in our HVAC business.

Adjusted gross margin for the 3 months ended March 31, 2024, was 34.8%, representing a 330 basis point increase compared to the prior year period, driven by price increases, improved business mix and inspection service and monitoring revenue as well as significant margin expansion and project revenues. Adjusted EBITDA increased by 18.4% on a fixed currency basis for the 3 months ended March 31, 2024, and adjusted EBITDA margin was 14.3%, representing a 200 basis point increase compared to the prior year period primarily due to the increase in adjusted gross margins, partially offset by growth investments. I will now discuss our results in more detail for our Specialty Services segment. Specialty Services reported revenues for the 3 months ended March 31, 2024, decreased by 9.5% to $389 million compared to $430 million in the prior year period.

Organic revenue declined 7.4% compared to 4% growth in Q1 2023, driven by a 14% decline in project revenues due to planned, disciplined customer and project selection and lower revenues from declining material cost pass-through. Service revenues were essentially flat. Adjusting for the exiting of one large customer relationship in our infrastructure and utility reporting unit, Services revenue would have increased by 11% in the quarter. Adjusted gross margin for the 3 months ended March 31, 2024, was 17.7% and representing a 440 basis point increase compared to the prior year period, driven primarily by disciplined customer and project selection, driving significant margin expansion in project and services revenue. Adjusted EBITDA increased by 21.4% for the 3 months ended March 31, 2024, and adjusted EBITDA margin was 8.7%, representing a 220 basis point increase compared to the prior year period, primarily due to the increase in adjusted gross margins partially offset by investments to support our service model and increases in certain legal expenses, including those associated with the completed divestitures.

I’ll now discuss cash flow. As we have highlighted in the past, the first quarter is consistently our lowest quarter for free cash flow generation. For the 3 months ended March 31, 2024, adjusted free cash flow was $12 million, reflecting an adjusted free cash flow conversion of 7% and representing a $12 million improvement compared to the first quarter of 2023. Adjusted free cash flow generation has been and continues to be a priority across APi and we are pleased we remain on track to achieve our adjusted free cash flow conversion target of approximately 70% for the year. During the first quarter, and as previously announced, APi reached an agreement with shareholders affiliated with Blackstone Tactical Opportunities Fund and Viking Global Equities to retire all the outstanding shares of their Series B perpetual convertible preferred stock.

Blackstone and Viking each converted all their Series B preferred stock into 32.5 million shares of common stock of APi. APi repurchased 16.3 million or half of the conversion shares from Blackstone and Viking for an aggregate purchase price of $600 million or $36.90 per share. The transaction was partially financed by an incremental term facility of $300 million issued at par. On February 28, 2024, we partnered with Blackstone and Viking as they launched a secondary public offering for approximately 12.2 million shares of APi’s common stock. As we mentioned before, this transaction simplifies our capital structure, eliminates the $44 million preferred dividend payment and has no impact on our M&A strategy. At the end of the first quarter, our net leverage ratio was approximately 2.8x before adjusting for the acquisition of Elevated Facilities Services Group announced on April 15 and the second quarter financing activities.

On April 16, we priced a primary follow-on offering for 12.65 million shares, raising over $450 million in net proceeds. Earlier this week, we launched a $550 million incremental term loan due 2029 with proceeds expected to be used to refinance our $330 million term loan due 2026, to repay $100 million of outstanding revolver balances and the remainder for general corporate purposes, including partially funding the acquisition of Elevated. Following the transaction and financing activities, we remain in a position of balance sheet strength, providing the flexibility to continue to execute our robust M&A pipeline at attractive multiples with a specific focus on opportunities accretive to our 13/60/80 targets. As we look forward to the rest of 2024, we expect to grow our adjusted free cash flow as well as improve our adjusted free cash flow conversion, providing us a continued opportunity for value-enhancing capital deployment including our planned bolt-on M&A campaign, while reducing our net leverage ratio to approximately 2.5x around year-end 2024.

I will now discuss our guidance for the second quarter and full year 2024. We continue to expect full year net revenue to range from $7.05 billion to $7.25 billion; adjusted EBITDA range from $855 million to $905 million; and adjusted free cash flow conversion for the year to be approximately 70%. This guidance has not been adjusted to include the impact from the Elevated acquisition, the divestiture announced this quarter and headwinds incurred from the strengthening dollar since our initial guidance announced on February 28, 2024. Based on our current foreign exchange rates, we expect an approximately $35 million headwind on revenue and approximately $5 million headwind on adjusted EBITDA for the full year. As Russ mentioned, we will update our full year guidance following the close of the Elevated acquisition.

In addition to adjusting for the contributions of Elevated, we will also incorporate the divestiture announced this quarter and update guidance for the impact of foreign exchange movements on the full year. As we move through the year, we will continue to remain focused on disciplined customer and project selection, our specialty and HVAC businesses. We expect to annualize against the majority of the planned slowdown in certain project work as we cross into the second half of 2024. This will allow for strong accelerating growth rates in both businesses in the second half of the year. In terms of the second quarter, excluding any impact from the Elevated acquisition, we expect reported net revenues of $1.75 million to $1.80 billion, reflecting the completed divestiture in Specialty Services and the foreign exchange environment.

The guidance represents an organic net revenue growth of approximately flat to 2% up as we lap our strong organic growth of 7.6% in Q2 2023, and as we continue to build a smaller but healthier backlog in our HVAC and Specialty Services businesses. We also expect to see a continuation of lower material costs, resulting in declining price pass-through versus the second quarter of 2023. This will result in lower projected project revenues. We expect to continue to expand adjusted EBITDA dollars and margin, which is reflected in our second quarter adjusted EBITDA guide of $220 million to $235 million, which represents adjusted EBITDA growth of approximately 9% to 16% on a fixed currency basis and adjusted EBITDA margin expansion of 140 basis points at the midpoint.

For 2024, excluding any impact from the Elevated acquisition and second quarter financings, we anticipate interest expense to be approximately $150 million; Depreciation to be approximately $80 million; capital expenditures to be approximately $95 million; and our adjusted effective tax rate to be approximately 23%. We expect our adjusted diluted weighted average share count for the year to be approximately 279 million, taking into account the Series B transaction and the primary follow-on offering of 12.65 million shares executed on April 16. I’d now like to turn the call back over to Russ.

Russ Becker: Thanks, Kevin. APi’s record first quarter profitability speaks to the effectiveness of our strategy and the alignment and its execution by our global team of leaders. As you’ve heard from us, we have great confidence in the business and the direction we are heading despite the volatile macroeconomic environment. The announced acquisition of Elevated, an expansion into the adjacent elevator and escalator services market, further strengthens APi’s competitive moat and expands exposure to statutorily driven demand for our services. As we look to the years ahead, we believe we can create sustainable shareholder value by focusing on our 13/60/80 long-term value-creation targets, all of which are accelerated by the announced acquisition of Elevated.

These include above-industry average organic growth; adjusted EBITDA margin of 13% plus by 2025; 60% of revenue from service, inspection and monitoring; and adjusted free cash flow of 80%. I am excited about the opportunities for the rest of 2024 and our ability to execute on our strategic plan in the years to come. With that, I would now like to turn the call back over to the operator and open the call for Q&A.

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Kathryn Thompson of Thompson Research Group. Your line is now open.

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Q&A Session

Kathryn Thompson: Hi, thank you for taking my question today. APG has focused on the inspection per strategy with – as you’ve outlined several times, growing margins through mix and scale. And so today, it’s north of 50%. It’s up from 40% prior to Chubb. As you enter into a new end market with the elevator – with this elevator end market, how does that fit into the inspection first strategy? And as you go down the road in building out that segment, where do you foresee it contributing to the 60% bogey the company’s outlined? Thank you.

Russ Becker: Good morning, Kathryn, thanks for your support and for participating this morning. So elevators, just like fire life safety systems are required by law to be inspected for functionality and operability at least annually, and it varies based on state and local jurisdiction, again, just like the fire life safety business. If you look at Elevated’s business, where we say 70% plus of their business comes from basically inspection, maintenance and repair, that falls right in line with our long-term goal of 60% of our revenue coming from inspection service and monitoring. That 70% plus is actually probably higher than that, depending upon how you want to slice and dice the modernization work, which is really their version of project-related work.

And a lot of the tuck-in M&A work that we’ll do as well as the organic growth that we’ll see inside this business comes from the inspection service and repair side of the business. The OEMs will continue to focus on the installation side, new construction side where the independent providers are more focused on the service and repair component of it. So this fits like right down the center of the fairway for us as it relates to continuing to focus on growing that piece and component of the business. And we’re super excited about the Elevated team. We’re also super excited about the opportunity for us to really grow in the space.

Kathryn Thompson: Thanks. And then just a follow-up question. Been a fair amount simplifying your capital structure for the quarter. Congratulations on that. But just to reiterate, does this change at all your capital priorities? And in particular, does it have any impact on your M&A initiatives that you’ve outlined previously?

Kevin Krumm: Hi, Kathryn, this is Kevin. I would say in short, no. Our priorities as we came into the year was to continue to focus a good portion of our free cash flow on stepping up our bolt-on and tuck-in M&A campaign. That is still the plan. We also had planned to pay down some debt later in the year, and nothing has changed there either. So our plan as we started the year and our priorities remains the same.

Kathryn Thompson: Perfect. Thank you, very much.

Operator: Your next question comes from the line of Andy Kaplowitz of Citi. Your line is now open.

Andy Kaplowitz: Good morning, everyone.

Russ Becker: Hi, Andy. How are you?

Andy Kaplowitz: Good. How are you? Russ, can you give us a little more color into core safety markets? Obviously, you continue to focus on project selection, but implied in your ‘24 guidance continues to be a relatively significant step-up in organic growth in the second half. So what’s your visibility at this point to step up? Is it really just the comp on increased project selectivity really starts in the second half? And are there any key verticals that you expect to drive the growth such as data centers?

Russ Becker: Well, clearly, data centers. So I mean, we’ve – the answer is we have really good visibility. We’re building backlog as we speak, and we’re building a really good healthy backlog as we speak. Data centers is contributing both in our Safety Services segment as well as our Specialty Services segment. And we also see strong wins in the semiconductor space. So I mean, I don’t think that anything has changed as it relates to the end markets that our business leaders are focused on today. And we’re still leading with inspections, but the project-related work that we’re bringing onto our books is all good, healthy work and healthcare, data centers, semiconductors, advanced manufacturing are all the right places for us to play.

Andy Kaplowitz: Appreciate that color. And then, Russ, maybe a little bit more color into the Elevated growth profile. I know you said it would deliver $220 million annually of revenue. But what should the growth look like over the next couple of years? And maybe versus that base, should it be accretive to APG’s growth or similar? And then how do you think about the synergy under cross-selling opportunities versus your core life safety business?

Russ Becker: Yes. So I mean, organically, the business has grown high single digits, and we don’t see any reason for that to change. Obviously, we would like to continue to accelerate that if we possibly can. We see a really strong opportunity for us in the bolt-on M&A space. It’s very similar, highly fragmented market, just like the fire life safety space is. So we see some opportunity there for, so to speak, non-organic growth to continue to complement that business. The cross-selling opportunity, we actually had some – we actually had the Elevated team on campus yesterday. And really, even though the transaction is not scheduled to close until later on in the quarter, but started conversations around what integration looks like and had some conversation around cross-selling and how we can potentially align branch offices and branch locations and the best way for us to do that is to get people sitting next to each other.

And that obviously is going to take a little bit of time for us to sort that out where we’ve got a good idea and we get good view into where we have overlap, so to speak, from a branch perspective. But getting that real estate footprint mapped out and consolidated is going to take a little bit of time for us to do that. But the more our business leaders get to know each other and really develop relationships, the easier and the faster you can facilitate cross-selling opportunities. But the Elevated team met with our business leader from our national accounts group yesterday to kick that process off. And so it’s – that’s a journey, and it’s going to take some time but we’re – we feel really good. I mean, everybody’s attitude is kind of in the right place and everybody is thinking about it the same way.

I mean there’s going to be some opportunities for us to take advantage of their customer relationships. And that’s something that we’re excited about.

Andy Kaplowitz: Appreciate the color, Russ.

Russ Becker: Thanks, Andy

Operator: Your next question comes from the line of Andy Wittmann of Baird. Your line is now open.

Andy Wittmann: Yes. Thanks for taking my question. I guess – excuse me. I wanted to ask about the services growth. I think you mentioned on the prepared remarks that it was 3% in the quarter. You also mentioned that the U.S. inspection business is growing double digit. So I guess, Russ or Kevin, could you just decompose a little bit and give some color behind the 3% growth rate? Were there larger customer exits in the international business perhaps that have held that back? Because it feels like the U.S. business is doing pretty well, but 3% is okay. But I think over time, certainly, your expectations are higher than that.