Q2 2023 APi Group Corporation Earnings Call
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Good morning.
Ladies and gentlemen, and welcome to API group's second quarter 2023 financial results Conference call. All participants are now in a listen only mode until the question and answer session. Please.
Please note this call is being recorded.
I'll be standing by should you need any assistance I will now turn the call over to Adam <unk>, Vice President of Investor Relations at API Group. Please go ahead.
Thank you good morning, everyone and thank you for joining our second quarter 2023 earnings Conference call. Joining me on the call today are risk factor, our president and CEO , Kevin Krumm, Our executive Vice President and Chief Financial Officer, and Chairman Martin Franklin and generally our board co chairs before we begin I would like to remind you that <unk>.
Any statements in the company's earnings press release announcements 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 detailed material risks that may cause our future results to differ from our expectations. Our statements are as of today August 3rd and we undertake no obligation to update any forward looking statements. We may make except as required by law. As a reminder, we have posted a presentation detailing our search.
<unk> quarter financial performance on the Investor Relations page of our website <unk> com.
Rents today will also include non-GAAP financial measures and other key operating metrics a reconciliation.
And other information regarding these items can be found in our press release and our presentation.
Now my pleasure to turn the call over to Jim.
Yeah.
Good morning, Thank you Adam.
<unk> delivered another strong quarter of results, including record net revenues adjusted EBITDA and adjusted diluted earnings per share and an evolving macro environment. We continue to be pleased with the momentum is building with an outstanding first half of 2023.
Excuse me.
And Kevin will speak to the performance of the business in more detail, but <unk> consistently strong financial results speak to the direction, we're heading and the strength of the company's recurring revenue service focused business model as well as the discipline of the organization and its leadership team.
We started this journey with Russell and the team nearly four years ago as a U S focused business with approximately $4 billion in revenues today, we're significantly larger with an expectation of delivering over $7 billion in revenue in 2023.
The quality of the business and our financial performance has also improved significantly we were the number one provider globally and a growing highly fragmented fire life safety market, we have confidence in the team's ability to expand adjusted EBITDA margins to 13% in 2025 and beyond as we continue to.
Increase our inspection service and monitoring revenues.
Since becoming a public company. The team has made measurable progress and demonstrated a track record of disciplined predictable and thoughtful decisions regarding capital allocation, maintaining our focus on tuck in M&A at appropriate multiples, while consistently delivering financial results above expectations across a very.
Bold macroeconomic backdrop.
We have great confidence in the business and we believe that our laser focus on our long term <unk>.
<unk> hundred 60, <unk> value creation targets will generate outsized investor returns through 2025 and beyond.
As a reminder, these include organic revenue growth above the industry average adjusted EBITDA margins of 13% in 2025 long term revenues of 60% from inspection service and monitoring and long term adjusted free cash flow a flow of 80%.
We look forward to updating you on the progress in the second half of the year and with that I will hand, the call over to Russ to talk about the real results.
Thank you Jim good morning, everyone.
Thank you for taking the time to join our call. This morning.
Jim mentioned, our $13 60, 80 long term shareholder value creation model that you see once again included in our presentation.
As I mentioned last quarter, we are relentlessly focused on driving this strategy with our specific focus.
The 13% adjusted EBITDA margins by 2025.
I continue to speak to our leaders about how they can help us deliver on this strategy when I'm visiting our locations around the world.
We are aligned as an organization and what we want to achieve and how to make it happen.
During today's call I will begin my remarks by briefly commenting on our record second quarter results as well as our continued progress towards delivering on our stated strategic goals in a macro environment that continues to be volatile.
He will then touch on the long term organizational investment behind our inspection first model and the benefits it is driving in our financial results.
Finally, a recap of our recent M&A activity and the positive momentum of the business before turning the call over to Kevin who will walk through our financial results and guidance in more detail.
As you've heard me say on prior calls the safety health and wellbeing of each of our 29000 meters remains our number one priority.
We remain grateful for their hard work and dedication to epi.
We believe we have a differentiated approach to leadership development for every key at epi, but specifically for our field leaders, who interact with our customers on a daily basis.
We will always prioritize investing in the many women in the field as human beings and aim to provide each of them with training leadership development and advancement opportunities.
At API, our field leaders have careers not just a job.
We prioritize this investment because we recognize that our success only happens in our branches and field leaders are successful.
This commitment is one of the foundational principles, we believe will continue to enhance shareholder value.
Turning to the second quarter and again pleased with our record results delivered by our global team as we continue to see robust demand for the services we offer across the business.
Net revenues grew organically by seven 6% in the quarter and by nine 7% year to date, reaching one $8 billion for the three months ended June 32023, representing the ninth straight quarter of mid single digit or higher organic growth.
<unk>.
Importantly, and in line with our strategic initiatives.
Saw a double digit increase in inspection service and monitoring revenue as we March towards our long term goal of 60% of total net revenues from inspection services and monitoring.
U S life safety continued its strong performance with organic growth of approximately 12% in the second quarter and approximately 16% year to date led.
Led by double digit plus inspection growth.
Which we have achieved in our U S life safety business each quarter since the pandemic.
In line with our strategic initiatives, we continue to see strong year over year improvement in adjusted gross margin in the second quarter up 160 basis points.
I am pleased with the leadership team's ongoing commitment to driving gross margin improvements through pricing activities growing higher margin service work and maintaining discipline and customer projects and end market selection.
I want to take a moment to update you on a critical investment we have made over the last decade to becoming inspection first organization.
And how this commitment drives financial results allows for more disciplined customer and project selection and helps to build a protective moat around the business.
We fundamentally believe that targeting statutorily mandated inspections at existing facilities and providing excellent service on those inspections drives repeatable business and create sticky customer relations relationships.
And those customers consider expansion plans, we are no longer competing solely on price, but instead can leverage our position as an excellent service provider with our customers to drive higher margin installation opportunities.
We target double digit quarterly growth in core inspection revenues and we are continuing to build what we believe is the best global inspection sales organization focused on driving this growth.
But it comes down to a lot more than just selling the inspection.
Inspections are highly coordinated process, requiring field and office collaboration with the customer.
This multi step process required a significant amount of infrastructure and training to do well as well as the right leaders in the field.
We have equipped our field leaders with best in class technology and invested in multiple scratch and training centers and programs to help to develop our field leaders and help enable them to provide great service to our diverse customer base.
Most competitors would rather pursue large installation jobs and recurrence of higher margin smaller invoice inspection work.
Our investment in and commitment to the inspection first model over the last decade as a key differentiator and has made growing inspection increasingly within our control.
We believe we are ahead of any competitor who would attempt to replicate this strategy and our insert investments salesforce and scale have created a large barrier to entry.
As a reminder, in most cases these inspections need to take place at least once per year or in some cases more frequently and we have data that every dollar foreign inspection revenue leads to an average of three to $4 of subsequent service revenue.
On average for inspection and service revenue comes in at 10% plus higher gross margins and project revenue.
We included a slide in the presentation that shows the 10 year journey of one of our branches. There was an early adopter of the inspection first strategy and its impact in that branch profitability overtime.
An underappreciated benefit of continuing to grow inspection service and monitoring revenues beyond service beyond serving our customers better is the ability to then be much more selective on the installation work, we choose to do resulting in margin expansion on the project side of the business as well.
For this specific branch EBITDA margins expanded from low single digits to mid 20% and less than 20.
In less than 10 years.
You can see the benefit of this approach come through in our consolidated results, where we have delivered gross margin expansion for six straight quarters, and an improved quality of the projects in our backlog, which remains healthy and strong.
Our leaders continue to execute this strategy across our branch network and I'm excited for the long term opportunity in our international business, where we are only in the early stages of instilling this strategy.
The international business continued to show progress with another quarter of solid growth as we continue to be intentional about targeting only work that is additive to achieving our 2025% 2025, 13% adjusted EBITDA margin target.
The $100 million value capture plan, which is another key contributor to our 13% target remains on track.
Moving on to M&A.
Our free cash flow generation and EBITDA growth in the first half of the year gives us confidence in our ability to reduce net leverage in line with our target net net leverage range of two to two five times.
Near the end of the year, while returning to bolt on M&A as.
As <unk> seen in our July press release, we announced our return to bolt on acquisitions that are immediately accretive to our adjusted EBITDA margin before synergies.
The markets we operate in are highly fragmented and a team remains focused on identifying the most attractive opportunities within our robust M&A pipeline.
I'm excited to continue to add new businesses and their leaders to the API family we.
We have strong momentum across our global platform as we enter the back half of the year, allowing us to again increase our full year financial guidance.
<unk> will provide details on our updated guidance in summary, while we remain focused on executing in the back half of the year I am proud of our team and how we delivered on our commitments and produced record financial results. So far in 2023.
Our field leaders continue to be the driving force of our performance I am truly grateful for what each of them has been to get us to where we are today I would now like to hand, the call over to Kevin to discuss our financial results and guidance in more detail Kevin.
Thanks, Ross and good morning, everyone.
Reported net revenues for the three months ended June 32023 increased by seven 4% to $1 8 billion compared to $1 6 billion in the prior year period.
Net revenues increased organically for the same period by seven 6% driven by strong organic growth in both the safety and specialty services.
Led by double digit growth in service revenues in the second quarter growth and safety services segment was approximately one half driven by price and one half by volume.
While growth in specialty services segment was primarily driven by increased volumes, which we measure through labor hours adjusted gross margins for the three months ended June 32003 through the 28, 3%, representing a 160 basis point increase compared to the prior year period, driven by price increases.
Outsized growth in service revenues and project margin expansion across both segments. These factors were partially offset by inflation, which caused downward pressure on our margins adjusted EBITDA increased by 16, 7% on a fixed currency basis for the three months ended June 32023 with <unk>.
<unk> EBITDA margin coming in at 11, 5%, representing an 80 basis point increase compared to the prior year period, primarily due to the factors impacting gross margin, partially offset by investments to support revenue growth and the continued build out of our global capabilities and infrastructure.
Adjusted diluted earnings per share for the second quarter was 41, representing a <unk> increase compared to the prior year period. The increase was driven primarily by strong organic growth and margin expansion in both safety and specialty services, partially offset by an increase in interest expense expense representing.
A 3% headwind to adjusted diluted earnings per share in the quarter I will now discuss our results in more detail for safety services.
Safety services reported revenues for the three months ended June 32020 through increased by six 9% to $1 2 billion compared to $1 1 billion in the prior year period net revenues increased organically by seven 3% driven by double digit core inspection revenue growth and robust growth in U S.
Life safety, partially offset by planned customer attrition in our international business and increased discipline and customer and project selection in our HVAC business adjusted gross margin for the three months ended June 32023 was 32, 4% representing record high adjusted gross margin.
180 basis point increase compared to the prior year adjusted gross margin driven by price increases improved business mix of inspection service and monitoring revenue as well as significant improvements in project margins, partially offset by inflation, which caused downward pressure on our margins.
Adjusted EBITDA increased by 18, 7% on fixed currency basis for the three months ended June 32023, and adjusted EBITDA margin was 13%, representing a 120 basis point increase compared to the prior year period, primarily due to the due to the factors impacting adjusted gross margin.
Partially offset by investments made to support revenue growth I.
I will now discuss our results in more detail for specialty services segment.
Especially services reported revenues for the three months ended June 32023 increased by seven 1% to $555 million compared to $518 million in the prior year period, primarily driven by double digit growth in service revenues led by growth in specialty contracting infrastructure.
Utility markets, partially offset by continued disciplined customer and project selection adjusted gross margin for the three months ended June 32003 was 19, 1%, representing a 170 basis point increase compared to the prior year period, primarily driven by strong organic growth and service rep.
As well as significant improvement in project gross margin was driven by disciplined customer and project selection adjust.
Adjusted EBIT increased by 15% for the three months ended June 32023, and adjusted EBIT da margin was 12, 4%, representing an 80 basis point increase compared to the prior year period, primarily due to the factors.
<unk> adjusted gross margin, partially offset by timing of some employee related expenses and other onetime costs.
We continue to focus on driving free cash flow conversion improvements year over year progressing towards our long term goal of 80% free cash flow conversion.
For the three months ended June 32023, adjusted free cash flow came in at $91 million, reflecting an improvement of $28 million versus the prior year period, and adjusted free cash flow conversion and 45% for the six months of the year, which as a reminder, seasonally slower than the back half.
Of the year, we delivered $75 million improvement in free cash flow when compared to the first six months six months of 2022.
Free cash flow generation has been and continues to be a priority across all of API and our performance in the first half of the year positions us to deliver on our 2020 through guidance of at or above 65% adjusted free cash flow conversion, representing an adjusted free cash flow delivery of over 500 million.
At the at the midpoint of our updated adjusted EBITDA guidance.
At the end of Q2, our net debt to adjusted EBITDA was approximately three nine times.
Even with a return to margin accretive bolt on M&A in the quarter. We remained laser focused on cash generation and deleveraging to our stated long term net leverage target of two to two five points with current expectations to be below two five times net debt to adjusted EBITDA by year end 2023.
Our balance sheet remains strong with a weighted average maturity is approximately five years with the earliest maturity in 2026.
I will now discuss our guidance for Q3 and full year 2023.
As a reminder, our guidance incorporates the expected impact from foreign exchange fluctuations, which we expect to be a modest tailwind in the second half of the year when compared to 2022 after being a headwind in the first half of 2023 I'm pleased with the performance year to date and the momentum of the business, which gives us.
Confidence to raise our prior full year guidance for reported net revenues and adjusted EBITDA.
We now expect full year reported net revenues of 7.015 to seven zero 75 billion up from six 875 to $7.0 million to $5 million.
At current currency expectations. This represents reported net revenue growth of approximately 7% to 8%.
We now expect full year, adjusted EBIT of 765% to $785 million up from $740 to $780 million, which represents reported adjusted EBITDA growth of approximately 14% to 17% and adjusted EBIT EBITDA margin of approximately 11%.
Around our commitments I.
I am confident in our leaders' ability to generate continued momentum in the business built on a historically strong execution and consistently drive margin expansion in any macro environment any macroeconomic environment through increasing high margin inspection service and monitoring revenue pricing initiatives operation.
Improvements in their relentless focus on customer and project selection.
As reflected in the increased guidance, Kevin just went through we had strong momentum across our global platform.
Backlog remains healthy and as planned we will continue to focus on the right work for the right customers in the right markets.
We believe we can create sustainable shareholder value by focusing on our $13 60, 80 long term value creation targets.
As a reminder, these include above market organic growth and adjusted EBITDA margin of 13% plus by 2025.
As we look to 2024 and beyond we have great confidence in the business and the direction we're heading.
With that I would now like to turn the call back over to the operator and open the call for Q&A.
At this time, if you would like to ask a question. Please press star one now on your telephone keypad to withdraw yourself from the queue. You May press the pound key one moment, while we queue.
Your first question comes from John John 10, one tank of CJS Securities.
Hi, Good morning. Thank you for taking my question. My first one just on the increased guidance how much of that contribution from acquisitions that you made recently and any changes in capex.
Any color on that would be helpful.
Ron I heard the first part of your question, So I'll answer that and the second part you want to come back to them.
So our most recent acquisitions.
<unk> announced as part of our July release or in our guidance.
The impact of that in the back half of the year from an EBITDA standpoint is.
At or around.
A couple of million dollars.
Okay, Great I was just wondering if that contribution as well.
FX contribution.
Yes, if any.
FX in the back half of the year.
At EBITDA will be similar.
<unk> $2 million to $4 million.
At current.
Currency expectations.
Okay, Great and then just looking at a little bit longer term.
Can you talk about the M&A pipeline that youre seeing even with smaller tuck ins that you've been doing or are you seeing more opportunities out there and is there the opportunity for anything that might be a larger more accelerated.
Thank you.
Thanks, John .
Thank you for your continued interest in the company.
Our M&A pipeline remains really robust and as we've shared in the past we've been focused on North America, primarily in or you are in the U S. In the life safety space.
Just partly because we see the same opportunities.
Available to us and our international business, but we remain focused on executing on our value capture program.
In that part of our business.
But the pipeline is really robust and I think our company leaders do a really good job of helping us build that pipeline along with our M&A leadership inside the company.
But there's plenty of opportunities and we continue to look forward to.
Assuming them and making sure that we add the right businesses too.
Family.
On these bolt on acquisitions the number one criteria for us is to find the right fit.
Make sure that we're culturally aligned team shared share count and values and when we do that Thats one of the I think one of the primary benefits we have as we as we think about why we're able to acquire these companies that reasonable purchase prices et cetera. So.
Lots of opportunity for us excited for what the.
Rest of the year is going to bring in potentially into next year.
Great. Thank you guys.
Your next question comes from Julian Mitchell of Barclays.
Hi, This is <unk> on for Julian.
Wanted to ask on life safety, the organic growth there this quarter and the first half was pretty strong. So I was just curious how much of that organic growth that you've seen year to date as is market related versus market share gains.
Hi, Karen this is Kevin.
I'd say that.
The lion's share of the growth that we're seeing in the U S life safety business is share gains we continue to win business.
Through our inspection first.
Model that.
Changes to feed them the service side of the business, but we're going out there and.
And taking business from competition and that's the primary driver.
Got it that's helpful and the market share gains or is it I know you talked about the market being very fragmented is it really smaller players that you are taking it from or other larger competitors that you are getting these market share gains from.
I mean, I think it's I think it's probably a little bit of both.
When you think about it and.
A key driver for US there is the continued build out and growth.
Our inspection sales team.
And as we continue to build that group out we will continue to take share.
As I mentioned in my remarks, the more traditional way of companies.
Capturing service and inspection work is to do the installation work first and then the installation work is basically 90% complete they try to approach that customer and sell them on service and inspection contracted we flipped that model lines here and are really really focused on calling on.
<unk> already built environment, and you know that Salesforce has out pounding the pavement and building relationships with potential customers.
And so you're you're taking that share away from whether that's a large player or a small player and it's about.
Having a different approach and a different tactic as we go after after that business.
Got it. Thank you and then just my follow up would be.
You talked about strategic pricing initiatives and I was just curious you know where are these focus and if youre getting any pushback from customers on them and if theres any churn as a result, thank you.