Q3 2020 APi Group Corp Earnings Call
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Good morning, ladies and gentlemen, and welcome to the H.P.S. group's second quarter 2020 financial results Conference call. All participants are now in listen only mode. Later, you will have an opportunity to ask a question. During the question and answer session. Please note. This call may be recorded I will be standing by should you need any assistance.
I will now turn the call over to Olivia Watson, Vice President of Investor Relations at Apiay Group. Please go ahead.
Thank you.
Good morning, everyone and thank you for joining our third quarter 2020 earnings conference call joining.
Joining me on the call today are Sir Martin Franklin and generally our board co chairs Ross Becker, our president and CEO and timeline in our Chief Financial Officer.
Before we begin I would like to remind you that certain statements and the company.
Press 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.
Dissipating 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 FCC, we detailed material risks that may cause our future results to differ from our expectations.
Our statements are as of today November 11, and we have no obligation to update any forward looking statement, we may make.
As a reminder, we have posted a presentation detailing our third quarter 2020 financial performance on 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 is now my pleasure to turn the call over to Martin.
Thank you Olivia.
We're very pleased with our third quarter results as well as the progress Weve made during our first year as a public company.
As I've said before.
Expected to be stress tested this quickly.
We believe that our results support the investment thesis, we had when we first met Ross and the team.
Oh sure priorities of the company stand out during difficult times, and we are proud of how everyone. Within the company has persevered as we navigate the corporate banking environment surrounding us.
We remain focused on our goal of building upon our Apds proven track record of organic growth within its niche business services markets complemented with disciplined and accretive M&A where.
We're excited about our recently announced acquisitions. These businesses are highly complementary and help expand our geographical reach in the important U.S. market and establish a beachhead for expansion on the continent in Europe.
With that I'll hand over the call to rough.
Thank you Martin good morning, everybody. Thank you for your interest in a P.I. I.
I Hope you and your families are staying healthy and safe.
Before I provide you with a summary of our strong third quarter financial results or M&A progress our positive outlook in our increased guidance you.
In honor of today being veterans day, I would like to start the call by thanking the servicemen and women as well as their spouses across our country for their sacrifices.
Value values and culture D. P. I have long been influenced by our leaderships respect in reference for the values of the U.S. military we are committed to hiring our nation's veterans, we have a long history of hiring and supporting veterans and have hired an average of 400 veterans 450 veterans and really over the past three years.
We are proud to have leaders that are investments in our workforce today.
We thank all of the best who are part of the team today and all the veterans that have been part of our family over the years.
Placing a bet in immense value on the leadership loyalty and experienced a military veterans and are fortunate to be able to work alongside those who have served our nation.
Hi, everyone was invested in <unk> to also invest in veterans and their spouses.
I'm very pleased with our results for the third quarter, particularly considering the ongoing impact of COVID-19, and the resurgence of COVID-19 in certain areas of the country.
Tom will take you through our results in more detail.
I'm proud of how our team has continued to show commitment and dedication to serving customers safely and efficiently.
The safety health and wellbeing of all of our employees and constituencies is our number one priority.
I'd I'd like to thank all of our leaders for their energy and enthusiasm during these challenging an unprecedented times.
As evidenced by the recent surge in COVID-19 cases, we will be dealing with the effects of the pandemic into next year.
However, we remain confident that we are well positioned and well capitalized to continue to execute on our long term goals.
We work hard to be proactive in preemptive in how we operate our business. We believe that our early expense reduction actions strong cash flow generation conservative balance sheet and liquidity profile provide us with a stable foundation to continue to navigate the uncertain economic climate.
Our ability to execute a myth amidst ongoing COVID-19 related disruptions is a testament to a variety of factors, which I'd like to cover in more detail.
First is our differentiated leadership culture in.
And the people centered business individual growth, both personal and professional the key ingredient in our long term success. We believe that one of our core pillars of success is our distinct leadership development culture predicated on building great leaders, our cross functional leadership development.
Our cross functional leadership development platform designed to enable independent company leadership cultivate broad management skills enhance organizational flexibility and empower the next cohort of leaders across our businesses. Many of our employees who are veterans have gone through this program. We believe that great leaders are competitive.
<unk> advantage and create shareholder value.
Second is our relentless focus on growing recurring service revenue, which we believe helps to build a more protective moat around the business as I mentioned on our last call. We define service as inspection testing maintenance and repair as well as work executed under our master service agreements and blanket contracts.
Service represents approximately 40% of our consolidated net revenues our long term goal is for 50% plus of our rest net breadth of our net revenues across all of our segments to come from recurring service revenue.
Third is the benefits of having a services focused business model that is well diversified across end markets customers and projects.
This provides us with stable cash flows and a platform for organic growth.
Maintenance and service revenues are predictable through contractual arrangements. Our average project size is well less than a million dollars across all of our segments.
Fourth is the compelling industry dynamics.
Hi, guys operations are focused on end markets and services that often have statutory requirements that tend to be economic economic cycle agnostic and RCC services segment. Our go to market strategy of selling inspection work first differentiates us from our peers and ultimately creates a stickier client relationship that we.
Believe leads to recurring revenue higher margin and growth opportunities. These inspections are often required by law in already built facilities and our required Rick regardless of whether the facility is built to capacity or empty.
In our specialty services segment, we are focused on partnering with customers that up projects. We believe our more macro economically resilient such as telecom customers, expanding fiveg technology, where our work with private and public utility customers with large committed capital programs. We believe that the long term investments being made by our.
Summers in this sector provide us with a high degree of visibility and contribute to the economic resiliency of our business.
Fifth is the relative variability of our cost structure, the variable cost nature of our business allows us to expand and contract our workforce as market conditions dictate without incurring significant trailing costs or severance. This is another aspect of the protective moat around our business.
The last point I'd like to touch on is our broad geographic footprint, we have 200 plus locations primarily in the U.S. in Canada and with an expanding platform in Europe. This footprint allows us to maintain relationships with local decision makers well also having the ability to execute multi site services for national account customers.
In addition, we support margin growth by leveraging our scale to benefit from procurement savings, resulting from any enhanced purchasing power. We continue to invest in back office infrastructure that we will then was that we anticipate will further help us leverage our scale as we move towards more of a shared services model.
Well, we don't know what the future impact of COVID-19 may be we remain cautiously optimistic well being realistic.
With the election behind US we are hopeful that perhaps an infrastructure bill might become a reality while not in any forecast, we certainly would expect to benefit from infrastructure investments.
We remain focused on our pre COVID-19 objectives and opportunities in front of US we believe that the markets in which we operate a highly fragmented and lend themselves to continued opportunistic opportunistic acquisitions.
We recently announced the acquisition of Sks fire safety group, a leading provider of critical safety services in the active fire in life safety markets in Benelux and Scandinavia through.
Through this acquisition, we have established a European platform for international organic and acquisition expansion to complement our position in the UK.
Well, we also announced three additional planned acquisitions in our safety services and specialty services segments. We remain on track to close all of these by the end of the year.
We are excited to welcome the leaders of these businesses to the IDE family.
Our recent acquisitions meet the key criteria for acquisition strategy, which include the following alignment of values and culture fit his.
History of strong free cash flow generated experienced management team with a proven record.
Service growth component.
And accretive to eat the ice financial profile.
Our pipeline of incremental M&A opportunities is robust and we expect to continue to explore opportunistic acquisitions as we move through the balance of the year and into 2021.
Our balance sheet is strong we ended the quarter with a net debt to adjusted EBITDA ratio of 1.8 times, and we have plenty of capacity and bandwidth to absorb additional accretive transactions.
Before I turn the call over to Tom I'd like to conclude my remarks by reminding you of our long term value creation targets. These include the following one deliver long term organic revenue growth above the industry average.
To continue to leverage our SGN eight three.
Three expand adjusted EBITDA margins to 12% plus by fiscal year 2023.
For adjusted free cash flow conversion of 80% plus.
Hi, gentlemen.
Generate high single digit average earnings growth and six target long term net leverage ratio of two to two and a half times.
I'd now like to hand, the call over to Tom to discuss our financial results.
This is bill to discuss our financial results in more detail, Tom Thanks, Russ and good morning I.
I will start by reviewing our consolidated financial results segment level performance as well as our strong balance sheet and liquidity and conclude with providing an update of our expectations for the remainder of 2020.
Adjusted net revenues for the three months ended September 32020 declined by $93 million or 8.9% to $953 million compared to a $1 billion in the prior year period.
The decline was primarily attributable to the negative impact of COVID-19 for the nine months ended September 32020, total adjusted net revenues declined by $255 million or 8.9% to 2.6 billion compared to 2.9 billion in the prior year period.
The decline was primarily attributable to the negative impacts of COVID-19, combined with improved project and customer selection, which led to a decrease in the volume of projects.
Adjusted gross margins for the three months ended September 32020 was 24.3%, representing a 159 basis point increase compared to prior year.
The increase was primarily due to our strategic focus on improving margins as opposed to growing the top line in the industrial segment Industrial services segment combined with the improved project execution in our safety and specialty services segment's margin.
Margin expansion was driven by mix of work increased labor productivity and improved pricing for the nine months ended September 32020, adjusted gross margins was 23.8% representing a 284 basis point increase compared to the prior year due to the drivers I mentioned for the third quarter.
Adjusted EBITDA margins, excluding corporate for the three months ended September 32020 was 15% representing 183 basis point increase compared to the prior year driven by gross margin expansion and early execution of our largely temporary SGN a cost containment efforts counteracting the negative impacts of COVID-19.
Adjusted EBITDA margin, including corporate was 12.1%, which is relatively flat compared to the prior year period due to increased costs associated with our transition to a public company and certain COVID-19 related expenses.
For the nine months ended September 32020, adjusted EBITDA margin, excluding corporate was 13.1% representing a 192 basis point increase compared to prior year driven by gross margin expansion and early execution of our largely temporary SGN a cost containment efforts counteracting the negative impact of COVID-19.
Adjusted EBITDA margins, including corporate was 10.6%, representing a 70 basis point increase compared to the prior year due to the drivers I mentioned.
We continue to execute on our we continued to execute on our cost mitigation efforts in the third quarter and had approximately $13 million of COVID-19 related SGN a cost savings, bringing our 2020 year to date total to approximately $32 million. The majority of these were due to temporary actions such as salary for one.
Okay, and competencies compensation related benefits that we began to unwind in June and continued throughout the third quarter.
Our strong cash generation has continued and our balance sheet liquidity profile remains strong for the nine months ended September 32020, adjusted free cash flow was 301 million, representing a $194 million increase compared to the prior year period of $107 million.
And our adjusted free cash flow conversion rate was approximately 108% exceeding our goal of approximately 80%.
The increase in cash flow was primarily driven by changes in working capital levels as the decline in net revenues resulted in reductions in our accounts receivable and fluctuations in our working capital balances that drove positive cash flow generation.
Our operating cash flow for the nine months ended September 32020, and included approximately $26 million of benefits, resulting from the deferral of certain payroll taxes under the Cures Act. We are estimating an additional 14 million of deferral payroll tax benefits in the fourth quarter. The total of approximately 40 million will be repaid.
In two equal installments in the fourth quarters of 2021 and 2022.
As of September 32020, we had approximately we had 699 million of total liquidity, comprising 467 million in cash and cash equivalents and 232 million of availability of borrowings under our revolving credit facility.
As of September 32020, we had $1.2 billion of indebtedness outstanding under our term loan and no amounts outstanding under our revolving credit facility, our net debt to adjusted EBITDA ratio calculated in accordance with our credit facility was 1.8 times as of September 32025.
Following the end of the third quarter to replenish balance sheet cash utilized in recent acquisitions, we entered into an incremental $250 million term loan facility, which maintains our strong liquidity position.
I will now discuss the results in more detail for each of our three segments.
And I'll start with safety services safety services net revenues for the three months ended September 32020 declined by 14.4% were $68 million to $404 million compared to $472 million in the prior year period. The decline was primarily due to negative impacts of COVID-19, such as building access restrictions.
And shelter in place orders, along with the timing of demand for mechanical services for the nine months ended September 32020, net revenues declined by $143 million for 10.7% to $1.2 billion compared to $1.3 billion in the prior year period due to factors I mentioned previously along with the timing of contract.
Revenue.
Service revenue represents about approximately 40% of the segment's net revenues for the three months ended September 32020 up from 34% in the prior year service revenue outperformed relative to contract revenue as expected increasing by 1.5% for $2 million to $160 million compared to 150.
$8 million in the prior year period.
For the nine months ended September 32020 service revenue represented approximately 39% of segment net revenues up from 34% in the prior year period.
Service revenue increased 8.3% or $1 million to $462 million compared to $461 million in the prior year period.
Adjusted gross margins for the three months ended September 32020 was 32.7% representing a 259 basis point increase compared to the prior year due to improved mix of service work and increased efficiencies for the nine months ended September 32020, adjusted gross margin was 31.6%.
Representing 188 basis point increase compared to the prior year, primarily driven by continued shift in mix of work towards inspection and service revenue.
As we have mentioned on prior calls on average we estimate that gross margins on inspection and service revenue or approximately 10% higher the gross margins on contract revenue.
Adjusted EBITDA margins for the three months ended September 32020 was 16.1% representing a 317 basis point increase compared to the prior year due to factors I mentioned as drivers of the gross margin improvement for the nine months ended September 32020, adjusted EBITDA margins were 13.8%, representing an 80 point.
Basis point increase compared to prior year due largely to the factors I've mentioned for the third quarter.
Specialty services.
The specialty services net revenue for the three months ended September 32020 declined by 1.7% or $7 million to 400 million compared to $407 million in the prior year the.
The decline was primarily due to negative impact of COVID-19, such as project deferrals and job site disruptions along with the timing of demand from our customers and the timing of projects.
For the nine months ended September 32020, net revenues declined by $58 million or 5.2%.
To $1 billion compared to $1.1 billion in the prior year due largely to the factors I mentioned for the third quarter.
Adjusted gross margins for the three months ended September 32020 were 18.8%, representing a 57 basis point increase compared to the prior year due to increased labor productivity and improved pricing for the nine months ended September 32020, adjusted gross margin was 17.1%.
Representing 135 basis point increase compared to the prior year due largely to the factors mentioned for the third quarter.
Adjusted EBITDA margins for the three months ended September 32020 were 14.3%, representing a 74 basis point decline compared to the prior period due primarily to the timing of income from joint ventures being stronger in the prior year.
For the nine months ended September 32020, adjusted EBITDA margin was 12% representing 81 basis point increase compared to prior year due to continued focus on project selection pricing improvements and stronger contribution from our joint ventures in the 2020 year to date period.
Industrial services, excluding two businesses that we classified as held for sale at the end of 2019, we divested group that we divested earlier this year industrial services adjusted net revenues for the three months ended September 32020 declined by 11.6%.
Or $20 million to $153 million compared to $173 million in the prior year period.
For the nine months ended September 32020, adjusted net revenues declined by $55 million or 12.5%.
Two $385 million compared to $440 million in the prior year period the.
The decline was primarily due to decreased volume as a result of our strategic focus on improving margins as opposed to growing top line and the negative impacts of COVID-19 on our customers.
Adjusted gross margin for the three months ended September 32020 was 16.3% representing a 362 basis point increase compared to prior year, primarily driven by the team's continued productivity increases due to improved project and customer selection project management and favorable jobsite conditions for the nine months ended.
Over 32020, adjusted gross margin was 16.9% representing 1029 basis point increase compared to the prior year due to the factors I mentioned for the third quarter adjusted.
Adjusted EBITDA margins for the three months ended September 32020 were 14.4%, representing a 455 basis point increase compared to the prior year, primarily as a result of our strategic focus on improving margins as opposed to growing the topline.
For the nine months ended September 32020, adjusted EBITDA margin was 13.8%, representing an 831 basis point increase compared to the prior year due largely to the gross margin improvements mentioned earlier.
Before turning the call over to Jim I'd like to provide our latest expectation for the remainder of 2020 as Russ stated earlier, we are cautiously optimistic yet realistic in our outlook.
Market conditions as a result of COVID-19 remain uncertain.
However, we're both pleased and comfortable raising our 2020 guidance, we believe that our adjusted net revenues for the year will range between 3.475 to 3.525 billion up from $3.4 billion to $3.5 billion.
Adjusted EBITDA will range between $360 million to $370 million up from $345 million to $355 million and adjusted EPS will range from $1.11.
To a $1.15 up from 94 cents.
Up from 94 cents to one dollar per share based on our adjusted diluted share count of $176 million.
We expect capital expenditures for the year to be approximately $40 million in normalized depreciation to be approximately $30 million.
Our cost of capital is approximately five cents.
And our job and our adjusted mid and long term effective tax rate remains approximately 21%.
I will now turn the call over to Jim.
Thanks, Tom and good morning, everybody.
As you heard today, we are pleased with our results this quarter, particularly in light of a difficult macro environment. While the pandemic continues to have a negative impact on net revenues across our three segments as expected our proactive approach to managing risk across our platform and the strength of our recurring revenue services focused business model.
He has yielded results.
Shortly following the end of the quarter, we proactively managed our capital structure by Opportunistically. It set accessing the debt the debt capital markets for an incremental term loan facility of $250 million provide us with additional financial flexibility to continue driving growth and creating shareholder value.
As a reminder, there are outstanding warrants, resulting approximately $245 million of cash coming into the company, which can be used for additional accretive acquisitions or other corporate needs.
As Russ mentioned earlier in the call we remain confident in our previously stated long term value accretion targets and believe the resilience of our people as well as our recurring revenue services focus business model will drive results and have allowed us to continue to execute our long term goals for the business. We believe that we are well positioned.
We're consistent profitable growth for our shareholders by optimizing the performance of our existing businesses pursuing a disciplined acquisition strategy and effectively managing our capital structure.
As we look at the calendar for Investor engagements over the next couple of months, we look forward to participating in the Baird Industrials Conference Tomorrow and virtual non deal Road show.
With with Barclays as well in December and yet again with CJ us and their conference in early January we plan to participate in additional conferences in India ours as we move towards the spring and also plan to host an analyst Investor day sometime in the spring, where we will share a 2021 outlook and our plan.
Sense for expansion.
I would now like to turn the call back over to the operator and open the call for question and answer with the remaining time.
And ladies and gentlemen, and on to ask a question. Please press star followed by the number one on your telephone keypad again its star one.
And your first question is coming from the line of markets.
Minimized with you yes.
Yes, hi, good morning, everybody.
Morning, Mark.
Yes.
Morning.
Question on the on the guide Thanks, a lot for that.
And what it implies maybe can you talk us through.
Looking here if I, if I do the math here it implies basically a high single digit down Q on Q is that kind of normal seasonality.
It's kind of in line with what you saw last year, maybe a little bit better Rois thats due cobiz impact that cautiously modeling here.
And then on margin maybe can you walk us through the cadence of the temporary cost outs, how do they come back lets see ton plan again, if I look at the Q4 implied it looks like you are.
Bring us towards a roughly 10% margin, but just thinking through the various puts and takes here on costs coming back and the topline guide maybe that stock there.
Joining me.
So thanks.
Thanks, Thanks, Marcus and we appreciate you vs. This coverage of the company as well.
So when you think about it right. The fourth quarter is typically we start to see some seasonality kick in both from a revenue perspective as well as from an SDMA perspective.
So as revenues slow SDMA will remain fairly consistent.
With within the existing businesses the other aspect of it as well is that we are continuing to bring you know the temporary cost containment measures back into play in the businesses and I would say you know for all intensive.
On purposes that we're almost back to a 100% and and so thats going to be adding some incremental costs due to our overhead structure.
We have some businesses that are continuing to remain.
I'll, just say reduced working with reduced wages.
But that has become the exception now.
And there is just a handful of us at corporate that are still not taking any compensation.
Okay got it. Thank you and then Jim you mentioned the board conversion into those.
The cash contribution of potential cash contribution from them.
Maybe can I tied that to your overall thoughts on M&A.
It's about LPC continuation of bolt ons also talks about.
On Sunday select positions in the path to what extent would you say SK fire safety is thus transformation to transition a transaction that you kind of talked about is that more of that nature that you are thinking about.
Given your leverage situation or how do you how would you advise us to think about the strategy going forward is leaning more towards bolt ons or is the other larger transactions with thinking about.
You know were markets, we're running a parallel path and so the historical M&A that the company has done with small regional companies local companies has continued.
You think of the acquisition announcement, we've made just at the end of the third quarter.
We have three of those little bolt on transactions that will close by the end of the year. We continue though to have conversations of things of scale I wouldn't say that SK. His transformational I think it was opportunistic.
It's around $175 million of revenue in us dollars and so.
I think that that is an appropriate size transaction, but as you know from our prior conversations.
We're willing to look at things much larger five six 700 billion.
We have the intellectual bandwidth within the organization to do a larger size, we certainly have the liquidity.
We're not relying on the conversion of the warrants, but that really represents almost a one for one and what we did in the debt markets and so yes, our leverage ratio will be will be low we have confidence in our ability to continue to generate cash. So we feel pretty good about that and so.
M&A is certainly in our line of sight.
Russ will actually be with Martin and I.
In the next couple of days to go through some of the larger M&A transactions. So we're confident that we'll be able to execute as we move through the balance of the year and into 2021.
And then if I could just kind of jump back to what Russ was talking about the fourth quarter.
We've said all along since the beginning of the pandemic that the revenue to shifting off to the right and ultimately you're going to be squeezed on revenue just because the calendar is going to end.
And so I think that that's really more reflective of where we see the fourth quarter rather than any change in our customers' outlook. The businesses focus we're simply just running out of time, we're heading into high holiday activity. Some more days will fall out of the calendar.
Theres nothing systemically challenging within the business other than the things we've discussed already.
Okay got it. Thank you thats very helpful. So basically in safety services that that 14.4% drop you had in the call that you've mentioned access restrictions.
Mechanical service, even though it may be shifting so we should really think of of the cobot impact more of a delayed not that these these projects developed rate. It's is it really so if we think about this is being pushed out to the next possible window whenever that is.
How would you how would you think about them.
I think that that's a very fair statement, but also it's a tough comp on a year over year basis, we had a good fourth quarter last year in this segment and so you know.
While people don't have a great track record of knowledge of the company.
Weather was favorable last year.
Due to the weather hasn't been terrible so far this year, but those are really the primary.
Tom and all the things that you just mentioned.
Hey, Marcus I get back Im sorry go ahead.
Mark to spike it out a little bit of color to why we don't publish our contract backlog arc. Our contract backlog is on a year over year basis is actually very consistent with where it was at this point last year if not.
Slightly higher by about $100 million so.
You know it is truly just.
As things getting pushed out as Jim has described and.
We feel like the company is really in a good spot.
That's very helpful. Thank you very much I get back in queue. Thanks, everybody.
Your next question is from the line of Andy Kaplowitz with Citigroup.
Hey, good morning, guys.
Hey, Andy how are you.
Good how are you rest maybe I can follow up on your last comment.
You talked about the backlog you mentioned service was up a little bit in the quarter minutes early to talk about 21, especially during a pandemic, but at the same time you do have your specialty business that looks like it's done to turn.
And you mentioned surface.
Safety, so any initial thoughts about 21 and the confidence level around growth in the business is maybe a more common into one segment versus another but any initial thoughts that you'd have.
Well, we're we're rolling up our 2021 budget as we speak I haven't seen really any of those figures at this point, but we remain confident in the business model that we put forth to you.
If you look at.
Our bellwether from in safety services ranges inspections rate and we talked a lot about how we are we're really just pounding the pavement as it relates to selling inspections first on a year over year basis inspections are up 6%.
I think thats, what we reported at the end of the second quarter in this in the call as well and so we've maintained that.
Through the third quarter in the middle of the Pandemics and so we believe that that continued focus in growth in services going to you know.
Very well for the for the business as we move into 2021, and our mechanical services businesses should see a resurgence in some of their work.
Work activities that were delayed as we went through the course of this year we.
We've talked a lot about specialty services being a cyclical and I think that that.
That those comments are accurate and they are proving to be accurate and we're we're very confident as we move into.
Fiscal 2001.
Good and you already talked about the temporary benefits sort of rolling off here, but even if I exclude that $13 million of benefits still did almost 11% adjusted EBITDA margin. So look I know you don't want to reset your margin target, but as we go into 21 is it possible to tell us or give us cause.
And how much structural cost maybe you've taken out of the business or versus you know we know you have things like.
Implementation back office consolidation. So I have you just been able to accelerate that more than you thought during the pandemic.
Well I'll, let Russell answer that for you raised the Andy we're not going to change her bathroom goals.
[laughter].
It's a nice short answer Jim, but any other color.
Yeah.
Go ahead, Chris.
Well I mean.
There is puts and takes right and when you think about it the.
As we continue to.
Bring these costs back we are also incurring some additional cost as it relates to becoming a public company and so we have to manage those expenses.
As well and need to include those in our forecast is as the as we move forward. So it's it's not a one size fits all its not just.
The expenses that were taken out in the individual businesses. So you have to look at it on a more macro basis. So Tom do you have anything to add to that I think you said it well.
And then Tom maybe one quick follow up for you on free cash flow obviously, good performance in 100, <unk> hundred 10% of EBITDA almost this.
This year is Q4 conversions still expected to be pretty good I mean seasonally I would guess it'd be relatively strong and.
He is there any way to highlight how much 2020 has been unusual for you because obviously, we know your target is 80%.
Yes, well it has been unusual I think the way to think about how it's been unusual if you're just trying to take a look at the the drop in Aer.
Thats driving a big piece of that improved cash performance.
And thats the direct connection to the revenue decline.
We do expect fourth quarter to continue to throw cash off as it has in the past on.
On a relative basis.
I would tell you Andy that we want to use some of that cash you know to to fund working capital, which means we're putting more people to work in getting more activity.
Within the businesses and.
And that's why I think it's important for people to continue to look at.
Our cash flow conversion goal of 80% you can.
Just look at it at any one point in time, you have to look at it.
Over a wider range of time.
Because we want to put some of that cash back to work.
Yes, and you'll typically see us also.
Have cash come in through the first couple months of the first quarter and then we start to have it typically go back out as Russ said for the right reasons, we're growing revenue growing activity and we're increasing receivables and our working capital needs.
Thanks, guys good execution.
Thank you. Thank you appreciate your support thanks.
Thanks, Andy.
Your next question comes from the line of Julian Mitchell with Barclays.
Hi, good morning.
We've had some fairly long question, so I'll try and keep it can size maybe the first one around.
The handful of acquisitions collectively juice at close.
And the next couple of months.
Perhaps help us understand what the free cash flow conversion profile of that sort of 25 million also with aggregate EBITDA is and also what's the expected three or five year.
ROI see on those various transactions.
Well, we would expect to free cash flow conversion on those businesses to be 80 plus percent, they're the right down the middle of the fairway as it relates to the.
To our business model, they're all focused on on the recurring revenue services component and so we would expect the casual conversions to be right right in our target range.
We don't turn Julien we don't.
Track revert on return on invested capital Thats not a metric that that we currently utilize we're focused on EBITDA and the.
Whether that's going to be accretive to our overall margin expansion goals.
Okay Fair enough and then perhaps.
Second question would be around the balance sheet. So obviously, the 1.8 times end of Q3.
Leverage ratio.
There's a lot of moving pieces now with cash out for the deals the EBITDA coming in.
Lauren conversion, so maybe help us understand let's say end of this year or early next once a lot of those things have played.
See the.
The leverage position being.
Yes. Thanks.
As we look to project through the end of it.
To the end of the year.
On our net basis, we think we'll be in front of that.
Two five to three range.
Net mid point.
Kind of a good place I think the Atlanta.
Yeah, Let me take you quickly as well our of our long term.
Targeting leverage as you know is.
Two to two and a hall, if the other $200 million, while it's about $250 million water proceeds of 245 minutes.
Comment obviously, the leverage ratio that Tom outlined would be somewhat lower.
Yes, and just Julie this is Jim if I could just kicking on this if you think about weve.
We ended the quarter at 1.8 will be around the two and a half to three times, that's really more of a function of the calendar that we did fourth quarter acquisitions, we fully expect to be on a normalized year in that range that Martin talked about.
I see thank you and so the implication would be you can you can carry on doing acquisitions, yes from early next year. There is no sort of digestion period, though or anything like that.
No it will be fine we'll be fine.
Perfect. Thank you very much.
Thank you.
Next question comes from the line of Andrew Wittmann with Baird.
Hi, great. Thanks for taking my questions I guess.
So to start I guess, maybe on the industrial services segment margins were obviously quite good and it's not lost on anyone I think that you guys have been focused on getting more profitable as expensive as revenue and Thats All fund will and good.
I think maybe the performance this quarter certainly exceeded our expectations I was wondering Tom if in the quarter. There is anything unusual in terms of.
Larger projects to close off Favourably in terms of accounting perspective, or anything that we should be aware of in terms of.
As it relates to the way, we would extrapolate the strong margin performance into the future.
No there was nothing unusual in the quarter from a sub.
Something closing out better.
Got it was working through different quarters, what was delivered in the quarter was very consistent with what we had expected.
For the industrial services segment.
We do expect.
The fourth quarter there to be smaller.
Just out of normal seasonality.
Great that makes sense and then Russ I was hoping you could just talk a little bit more about some of the delays that you've seen it sounded like it was mostly in the mechanical portion of the safety services segment.
I was just wondering about the nature of those projects are those build outs of commercial offices or if you could just be a little bit more specific so we could understand which which key markets are being mostly affected by the delays today.
I would say probably healthcare in.
In safety services is the is the primary place so we saw some.
Saw some things push out to the right we haven't seen anything cancel.
But.
Not not commercial real estate.
You think about our end markets that we serve I mean, we're not in that developer led market to any great extent and I think thats one of the advantages.
And that we have that doesn't mean, we don't do any commercial office work, but.
I'd say healthcare as the primary end market specialty service services had some of our industrial clients on delays some of their.
Outage work, if you will maintenance outage work were you know whether it's a mining operation.
You know had scheduled planned outages.
Some number of those were delayed and pushed out just because they didn't want to have the risk of a coded outbreak in the middle of that maintenance outage.
Would potentially delay the start up of their facilities. So.
We saw we saw some delays really in in both segments.
Got it Thats helpful. And then I guess my last question here is just regarding the.
The acquisition in Europe, and opening up that new growth opportunity I, just was hoping you could talk a little bit about how.
You as historically North American focused company got comfortable with.
Certainly the same types of businesses, but really in new markets in the new market dynamics that come with different cultures different regulations different labor labor rules.
It's certainly probably a different customer sets a similar customer type, but different customers themselves. Although things are important I think as you as you decided to put capital. There I was just hoping you could walk us through a little bit of the process that you went through to get comfort with us in this deal.
Yes so.
So we have to be.
The business Thats based in the UK that.
We've had for a number of years and we've always had some interest in continuing to grow our platform in.
In the UK in in Europe, and in general and so ESG.
It's really a great opportunity I would tell you that the business is right down the center of the fairway for US I mean, the services they provide the work that they do.
There is great synergy between the.
Services that we provide in our safety services and we've already started to collaborate with the ESG team and our safety services team odd how can we leverage our spend with our vendors and so on and so forth. So.
Mike I don't look at ESG team as a stretch or reach for us by any stretch of the match at machination, It's not it's not a huge business, it's not a big business, we really like the the leadership team there. They are rock solid and I think it is.
Right down the center of the fairway, So I it and then the other part of it is is that you know.
Martin Franklin is involved with Nomad foods, and so they've already got.
Tremendous amount of experience in the European markets that we're going to be able to to lean on.
In addition to the experience that we have been working there as well. So we're very comfortable we think it's exciting we're already exploring a couple of small bolt on acquisitions desk Feig, and we think thats going to be a great platform for us to to move forward with.
Great. Thanks, a lot.
Andrew we'll see you at your conference Tomorrow.
I'm, just going to tee up as.
As we're talking about acquisitions and since we have Martin on the phone.
A lot of people have asked us about multiples that we paid in Martin do you want to give some color just on how we're thinking about acquisitions and multiples.
Yes, so I mean.
As you probably.
Investors, who sort of know the space in the fund then you look at some of the other service companies that have been sold of light companies like pipe off sub its logic companies like them that have been traded that.
14 to 16, plus EBITDA multiples.
You know people, who know us long enough to know that that's not really our code we'd like to trade at those levels.
Really.
Buyers at those levels, we've tried to.
Find the right if you like arbitrage between us.
Small and large and the smaller acquisitions as I think you all know trade in the through call. It mid single digit multiples thats the norm for the smaller companies when you get to mid size those multiple stopped moving up as you probably saw with SKG and I think you should use that as the model for how.
We look at acquisitions, obviously from our perspective, we look at our entry multiple and Ipi, which you know has been awarded investors. So far and I think has quite a long way to go.
But philosophically, we're going to use the same disciplines that we've used over many many years on how we buy.
Which is we want to buy things that are the right fit fit all of our criteria to call up boxes and come at an appropriate valuation so.
Yeah.
We we don't use sort of one size fits all we're opportunistic but.
But we think the door is still very much open for us to do these series of smaller acquisitions and one of the things that hasn't really been said, but it's very compelling part of the story from the very beginning for us.
If you look at the prices that you can pay for the smaller acquisitions, you really are self funding in perpetuity as you continue to grow and there's so many in such a fragmented market. There were so many companies you really don't need additional capital.
For the company to roll out those acquisitions.
In various geographic markets. So that continues to be very high on the priority list for acquisitions.
The extents the extent, we can create additional platforms and take a sells into new territories like we did with SK with SK G.
That's the strategy, we're going to pursue so.
We expect more of the same kind of philosophy going into the next three to five year program.
Operator, who's up next in the queue for questions.
Your next question is from the line of Adam Thalhimer with Thompson Davis.
Hey, good morning, guys. Congrats on a great Q3.
Thank you Marty good.
Can you give us a little more color in the safety business I'm surprised that revenue was down as much as it was.
In Q3 why was that.
And then is that something that just sets you up for kind of an easy comparison next year.
Well I'll say no to that part of the question ill answer the first part.
Well I mean, it's not it's not a 100 you know there's we have mechanical services in inside safety services, as well and Thats, where the that's where the the primary impact was we also have a we have certain locations that were impacted by coded on more so than than others and.
And.
So there is there is there is an element of looking at it from a geographic basis as well you know there is markets like think about New York and the impacts that New York at compared to the rest of the country and their ability to.
To recover and get back on a more normal cadence so like we track man hours.
By we for every single one of our companies and we've watched our man hours kind of tick up tick up pick up and pick up but certain marketplaces has had slower.
No I guess rates of tick up if you will.
Based on the different shelter in place orders and New York being one of those and we like where the business is he is at now today, but it's taken longer for that business to ratchet back up and get to more normal levels and so you're managing that across all aspects of the business our Canadian business, we're the largest provider of life safety.
Services in Canada, as well and.
Yes, specifically like Toronto went into a greater level of locked down than some of the other markets and it's the same thing we're watching those hours kind of ticked back up and get back to up to a more normal place and so it varies by business and.
So you have to make decisions.
Based on the variability in each one of those businesses and how you how you react and respond.
Okay, and Russ is probably way too early but there was a school of thought.
That done post.
Post election, and now we have positive vaccine news on top of that but there was a school of thought that some of these delayed work would start to move forward post election, and then I guess now we have positive vaccine news probably way too early but I mean are you seeing an uptick from.
From those events.
Well I think its diving is much much too early I mean in the vacs. The vaccine is not going to be readily available to you know every day America for a number of months and so we are we are looking at our business and we are continuously planning.
You know like Theres, the second wave and what's going to happen. What is your plan. So that you can respond and react and we expected things are going to change again by markets. So like if you look if you look at it like yesterday, the Governor, Minnesota came out with more restrictive.
You know actions because the cove. It now I don't think its going to affect our business at all.
But.
You have to continue to observe what each individual community and state is doing.
And so that you can properly respond and react to the market conditions that you have and I think that we've demonstrated that.
That we are proactive and we are going to manage our individual businesses based on the situations in the conditions that we're faced with but.
I think it's I think it's too early to tell our backlog is solid I mean that gives us great confidence as we move into 2021.
And beyond but.
Like I said I call it productive paranoia and.
It means it's like always you know keep one eye open in the back of your head and to make sure that you're in a position where you can respond to the conditions that you are faced with.
No and.
Good job on flex and yes, the EBITDA margins in light of the topline are very impressive.
Who is.
You know one of the things you have to also think about the relative to the election and I'll just call it relative certainty as we head into next year.
As Russ mentioned on the call.
There are infrastructure opportunities for us.
Both in safety and the U.S specialty services business.
Congress gets its act together and moves forward on infrastructure, we just view that as kind of an upside surprise.
We're not planning for anything but you know it.
It is a tailwind if it happens.
Understood. Thanks, guys.
Thank you too.
Your next question comes from the line of Kathryn Thompson with Thompson Research.
Hi, Thank you for taking my questions today.
And I appreciated the color on that.
Pools with acquisitions that was actually the part I was going to shut down so thanks to answer that but following up on your Q3 remaining acquisitions that you can be closing this quarter.
If you give a little bit more detail just bigger picture in terms of the strategic thinking and how these companies fit into the growth trajectory for the company.
And then also I understand that many are just part of the bigger picture, but really want to be able to think because when you explained it to me it gets it.
Rich a picture of how you're thinking strategically going forward. Thank you.
Thanks Catherine.
For your question and thanks for participating in the call today, we appreciate it very much.
So I would tell you that.
All of all three of these transactions are geographically complimentary to our to our footprint and.
That is something that's very important for us as we continue to build out the platform.
Specifically in safety services, but the the acquisition and specialty services again is geographically complimentary to our existing business. So that's one key driver for us.
They are all focused on service and the recurring revenue component of service and so that's that's a positive.
For us as well and these are good people and they fit our culture and they share our values and for US. It's it's just a great opportunity for us to add quality people to the.
As family the thing that we know is that from an operational and when you think about it from an operations perspective, we know that through our strength in buying today that we can help improve those businesses. The results from day, one and so there's just a tremendous amount of opportunity for us to continue to do it earlier in the call today, we talked about.
You know some of our corporate clients and we talked about having 200 plus locations across really North America, and we need to continue to expand on that and the non especially in safety services as we continue to put more.
Geographic.
I'll just call it from tax on the map if you will they're better we're able to service our corporate clients on from an inspection for SEC across across to us in Canada. So these these businesses all fit right in into our sweet spot and what we're trying to accomplish.
Thank you and then just following up on the margin call you gave us.
He showed that there is a mix between.
Later surface.
And also in pit efficiencies for the quarter at least it could you help us parse out in greater detail, how much that was mix versus efficiencies and cost cutting measures.
Hey, you talked about it generally that would be helpful to say listen half of it was.
Next person and the other half for cost cutting.
Yes, I think Youre directionally right there.
It's very difficult for us to have that information.
Any tighter than than what you've described there. It's a combination of many levers theres a little bit of pricing improvement that we had.
There was little bit of better execution, we're in a time with covance debt.
We have some instances that we can get to places quicker because there's less cars.
Cars on the road, but then we have an offset to that but we've got we can't put two people in a truck to go to work on a project. So we've got to be ongoing.
So its a little mix of everything, but but I think you directionally its cost containment and then better execution and.
Really working as we have on reducing our contract loss rate as well.
Okay, and then I guess that leads into my last question for today.
Theres been a great deal of focus on project selection.
Selection and reducing your loss rate overall could you give an update just in terms of how these best practices towards that goal or being implemented across the.
The organization and then what is the ultimate goal in terms of margin upside.
To this specific initiatives.
And just final point to that where are you today versus a year ago in this journey.
So I would I would share with you that we've gained on it and we we shared I think that we had a contract loss rate of 1.5%.
Last year.
We have set a goal this year to to reduce that by half and we gained on that we're not 100% there, but but we gained on it now you just do the simple math I mean, if it's 1.5% and we get to zero you got to 1.5% gain so I mean, it's the you can you can figure out how that impacts our mark.
Engine.
Just intuitively.
Like.
It should be zero and that's what that's what the goal is it should it makes me it. It makes me throw up on myself to think that.
You know that we take money out of our pocket so to speak to go provide services to some of our customers and so we have to be disciplined and we have to be better. So we've implemented a we've always had a.
Process.
So to speak and notification process for larger opportunities for the company, but we've really instituted a much more disciplined go no go check.
Check list that is actually.
An app that people have on their devices that they go through two before they even submitted or put a pencil to paper as it relates to preparing a proposal for their client and.
And when they get to a certain size they actually have to come across my desk, even if it's a master service agreement, that's got $15 million of opportunity incited that are all.
50000 dollar opportunities that roll up to this large master service agreement it comes across my desk and I see it and so it's it's I guess, bringing more disciplined to our business as it relates to who do we want to work for in an almost every situation Kathryn It comes down to really who is the customer.
And we want to make sure that we're being really selective in who we're working for it.
And Kathryn it's Jim.
Very good question, it's all part of our path to the 12% plus we don't have any home runs built into this is all a bunch of singles and doubles. So we're not reliant on any one item to get us to that margin expansion goal for 2023.
With that came in to cut you off but we're a little bit over the time.
We have CJ us out there, which is everybody knows was the first guys launch coverage on us and so I think we should end with them looking at your question, but I know you guys have other calls and we have calls with investors. So if we have John and CGS.
Yes, one moment.
And John his line is open.
Okay, Hey, guys. Thank you on that thank you for letting me on we really appreciate your support a lot of my questions have been answered I know, we're short on time I'll just keep it to one.
Just wanted to grow Jones as kitschy a bit I was wondering first what was the contribution you are.
Expecting in your Q4 guidance from Medicaid.
It's about a penny and a half or about $4 million.
In EBITDA.
And call it 40 million in revenue.
Okay.
My apologies Johns line has disconnected.
Well I guess everybody through my answer to John's question I missed your John hurt it.
But with that.
When we wrap it up Russ you want to close us out.
No I'd add Jim My what I, just want to take the opportunity to thank everybody again for joining the call. This morning and really thank you for your interest in any CPI we.
We're very proud of where we're at today, it's been a long journey.
For the first year of being a public company with amidst the pandemic, but.
But we have a great team Eddie Im very proud of our people and very feel very fortunate and blessed to be able to work alongside them. So thank you and we look forward to visiting with each of you in the coming days.
Thanks very much.
Okay.
Thank you ladies and gentlemen concludes today's conference call. We thank you for participating.
Thank you disconnect your lines.
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