APi Group Corporation

Good morning, ladies and gentlemen, and welcome to the API's Group Second Quarter 2020 Financial Results Conference Call. All participants are now in a 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 Walton, Vice President of Investor Relations at API Group. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining our third quarter 2020 earnings conference call. Joining me on the call today are Sir Martin Franklin and Jim Lilly, our board co-chairs, Russ Becker, our president and CEO, and Tom Lydon, our chief financial officer. 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, November 11th, 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 we've made during our first year as a public company. As I said before, we had not expected to be stress tested this quickly. We believe that our results support the investment thesis we had when we first met Russ and the team. The culture and 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 COVID-19 environment surrounding us. We remain focused on our goal of building upon API's proven track record of organic growth within its niche business services markets, complemented with disciplined and accretive M&A. 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 Russ.

Thank you, Martin. Good morning, everybody. Thank you for your interest in API. 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, our M&A progress, our positive outlook, and our increased guidance, 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. The values and culture at API have long been influenced by our leadership's respect and reverence 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 annually over the past three years. We are proud to have leaders that are veterans in our workforce today. We thank all of the vets who are part of the team today and all the veterans that have been part of our family over the years. We place an immense value on the leadership, loyalty, and experience of military veterans and are fortunate to be able to work alongside those who have served our nation. I encourage everyone who is invested in API 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 am proud of how our team has continued to show commitment and dedication to serving customers safely and efficiently. The safety, health, and well-being of all of our employees and constituencies is our number one priority. I'd like to thank all of our leaders for their energy and enthusiasm during these challenging and 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 and preemptive in how we operate our business. We believe that our early expense reduction actions, strong cash flow generation, and conservative balance sheet and liquidity profile provide us with a stable foundation to continue to navigate the uncertain economic climate. Our ability to execute 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 a people-centered business, individual growth, both personal and professional, is a 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 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 a competitive 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 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 any 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. EPI's operations are focused on end markets and services that often have statutory requirements that tend to be economic cycle agnostic. In our safety services segment, our go-to-market strategy of selling inspection work first differentiates us from our peers and ultimately creates a pickier 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 are required regardless of whether the facility is filled to capacity or empty. In our specialty services segment, We are focused on partnering with customers that have projects we believe are more macroeconomically resilient, such as telecom customers expanding 5G technology or our work with private and public utility customers with large committed capital programs. We believe that the long-term investments being made by our customers 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. and Canada and with an expanding platform in Europe. This footprint allows us to maintain relationships with local decision makers while 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 enhanced purchasing power. We continue to invest in back office infrastructure that we anticipate will further help us leverage our scale as we move towards more of a shared services model. While we don't know what the future impact of COVID-19 may be, we remain cautiously optimistic while 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 are highly fragmented and lend themselves to continued opportunistic acquisitions. We recently announced the acquisition of FK's Fire Safety Group, a leading provider of critical safety services in the active fire and life safety markets in Benelux and Scandinavia. Through this acquisition, we have established a European platform for international organic and acquisition expansion to complement our position in the U.K., 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 API family. Our recent acquisitions meet the key criteria for API's acquisition strategy, which include the following. Alignment of values and culture fits. History is strong free cash flow generated. Experience management team with proven records. service growth component, and accretive to API's 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. Two, continue to leverage our SG&A. Three, expand adjusted EBITDA margins to 12% plus by fiscal year 2023. Four, adjusted free cash flow conversion of 80% plus. Five, generate high single-digit average earnings growth. And six, target long-term net leverage ratio of two to two-and-a-half times. I would now like to hand the call over to Tom to discuss our financial results in more detail. Tom? Thanks, Russ, and good morning.

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 30, 2020, declined by 93 million, or 8.9%, to 953 million, compared to a billion in the prior year period. The decline was primarily attributable to the negative impacts of COVID-19. For the nine months ended September 30, 2020, 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 30, 2020, 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 services segment, combined with the improved project execution. In our safety and specialty services segments, margin expansion was driven by a mix of work, increased labor productivity, and improved pricing. For the nine months ended September 30, 2020, 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. Adjected EBITDA margins excluding corporate for the three months ended September 30, 2020 was 15%, representing 183 basis point increase compared to the prior year driven by gross margin expansion and early execution of our largely temporary SG&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 increase in costs associated with our transition to a public company and certain COVID-19-related expenses. For the nine months ended September 30, 2020, adjusted EBITDA margin, excluding corporate, was 13.1%, representing 192 basis point increase compared to prior year. driven by gross margin expansion and early execution of our largely temporary SG&A cost containment efforts, counteracting the negative impact of COVID-19. Adjusted even of 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 cost mitigation efforts in the third quarter, and had approximately 13 million of COVID-19-related SG&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, 401 and 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-month end of September 30, 2020, 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 30, 2020 included approximately 26 million of benefits resulting from the deferral of certain payroll taxes under the CARES 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 30, 2020, 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 30, 2020, 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 30, 2020. 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 positions. 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 30, 2020 declined by 14.4% for $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 our mechanical services. For the nine months ended September 30, 2020, net revenues declined by $143 million, or 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 30, 2020, up from 34% in the prior year. Service revenue outperformed relative to contract revenue as expected, increasing by 1.5% or $2 million to 160 million compared to 158 million in the prior year period. For the nine months ended September 30, 2020, service revenue represented approximately 39% of segment net revenues, up from 34% in the prior year period. And service revenue increased 0.3% or $1 million to 462 million, compared to 461 million in the prior year period. Adjusted gross margins for the three months ended September 30, 2020 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 30, 2020, 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 are approximately 10% higher than gross margins on contract revenue. Adjusted EBITDA margins for the three months ended September 30th, 2020 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 30, 2020, adjusted EBITDA margins were 13.8%, representing an 80 basis point increase compared to prior year, due largely to the factors I've mentioned for the third quarter. Specialty services. Specialty services net revenue for the three months ended September 30, 2020, declined by 1.7% or $7 million to $400 million, compared to $407 million in the prior year. The decline was primarily due to negative impacts 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 30, 2020, 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've mentioned for the third quarter. Adjusted gross margins for the three months ended September 30, 2020 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 30, 2020, 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-month end of September 30, 2020 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 30, 2020, adjusted EBITDA margin was 12%, representing an 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, that we divested earlier this year, industrial services adjusted net revenues for the three months ended September 30, 2020, declining by 11.6% or $20 million to 153 million compared to 173 million in the prior year period. For the nine months ended September 30, 2020, adjusted net revenues declined by $55 million or 12.5% to $385 million compared to $440 million in the prior year period. 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-month end of September 30, 2020 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 job site conditions. For the nine-month end of September 30, 2020, adjusted gross margin was 16.9%, representing a 1,029 basis point increase compared to the prior year, due to the factors I mentioned for the third quarter. Adjusted EBITDA margins for the three months ended September 30, 2020 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 top line. For the nine months ended September 30, 2020, 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 are 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 to 3.5 billion. Adjusted EBITDA will range between 360 to 370 million, up from 345 to 355 million. And adjusted EPS will range from $1.11 to $1.15, up from 94 cents up from 94 cents to a 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 and normalized depreciation to be approximately 60 million. Our cost of capital is approximately 5% and our adjusted mid and long-term effective tax rate remains approximately 21%. I will now turn the call over to Jim.

Thanks, Tom. 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 has yielded results. Shortly following the end of the quarter, we proactively managed our capital structure by opportunistically accessing the debt capital market for an incremental term loan facility of $250 million to provide us with additional financial flexibility to continue driving growth and creating shareholder value. As a reminder, there are outstanding warrants that would result in 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 creation targets and believe the resilience of our people as well as our recurring revenue services focused 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 to deliver consistent profitable growth for our shareholders by optimizing the performance of our existing businesses pursuing a discipline 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, a virtual non-deal roadshow with Barclays as well in December, and yet again with CJS and their conference in early January. We plan to participate in additional conferences and NDRs as we move towards the spring of and also plan to host an analyst investor day sometime in the spring where we will share our 2021 outlook and our plans for expansion. I would now like to turn the call back over to the operator and open the call for question and answer with our remaining time.

Operator. Ladies and gentlemen, in order to ask a question, please press star followed by the number one on your telephone keypad. Again, that's star one. And your first question is coming from the line of Marcus. Mittermeier with UBS.

Yeah, hi, good morning, everybody. Good morning, Markus.

Good morning, hi. Quick question on the guide. Thanks a lot for that and what it implies. Maybe can you talk us through your thinking here? 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, or is that still COVID impact that you're 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? What's your current plan? Again, if I look at the Q4 implied, it looks like you're gearing us towards a roughly 10% margin. So just thinking through the various puts and takes here on costs coming back and the top-line guide, maybe let's start there.

So thanks, Marcus, and we appreciate UVS's coverage of the company as well. So when you think about it, all right, the fourth quarter is typically we start to see some seasonality kick in, both from a revenue perspective as well as from an SD&A perspective. You know, so as revenues flow, you know, SG&A will remain fairly consistent, you know, 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 intents and purposes that we're almost back to 100%. And so that's going to be adding some incremental cost to our overhead structure. You know, we have some businesses that are continuing to remain on, I'll just say, reduced, working with reduced wages. But that has become the exception now. And there's just a handful of us at corporate that are still not taking any compensations.

Okay, got it. Thank you.

And then, Jim, you mentioned the foreign conversion and sort of the cash contribution, potential cash contribution from that. Maybe can I tie that to your overall thoughts on M&A? You've talked about, obviously, continuation of fold-ons. You've also talked about transformation-like decisions in the past. To what extent Would you say SK Fire Safety is that transformational transaction that you kind of talked about? Is there more of that nature that you're thinking about given your leverage situation? Or how would you advise us to think about the strategy going forward? Is it leaning more towards the bolt-ons or is there other larger transactions that you're thinking about?

You know, Marcus, we're running a parallel path. And so, you know, the historical M&A that the company has done with, you know, small regional companies, local companies, has continued. You know, if you think of the acquisition announcement we made just at the end of the third quarter, you know, 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... is transformational. I think it was opportunistic. You know, it's around 175 million of revenue in US dollars. And so I think that that, you know, is an appropriate size transaction. But as you know, from our prior conversations, you know, we're willing to look at things, you know, much larger, five, six, 700, a billion. You know, 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, you know, that really represents almost a one-for-one of what we did in the debt markets. And so, you know, our leverage ratio will be low. We have confidence in our ability to continue to generate cash. So we feel pretty good about that. And so, you know, 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, you know, we've said all along since the beginning of the pandemic that the revenue is shifting off to the right. And ultimately, you know, 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 customer's outlook, the business is focused. We're simply just running out of time. We're heading into high holiday activity, you know, so more days will fall out of the calendar. But there's nothing systemically challenging within the business other than the things we've discussed already.

Okay, got it. Thank you. That's very helpful.

So basically, in safety services, that 14.4% drop you had in the quarter, you've mentioned access restrictions, you know, mechanical issues. service windows may be shifting. So we should really think of that COVID impact more as a delay, not that these projects evaporate. Is it really sort of we think about this as being pushed out to the next possible window whenever that is, or how would you think about that?

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, the weather was favorable last year. You know, the weather hasn't been terrible so far this year. But those are really the primary drivers is a tough comp and all the things that you just mentioned.

Hey, Marcus. I'll get back in. Go ahead.

Marcus, if I could add a little bit of color, too. You know why we don't publish our contract backlogs? 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, you know, things getting pushed out, as Jim had described. And, you know, we feel like the company is really in a good spot.

That's very helpful. Thank you very much. I'll get back in queue. Thanks, everybody.

Our next question is from the line of Andy Kapulitz with Citigroup.

Hey, good morning, guys. Hey, Andy. How are you? Good. How are you? Russ, maybe I can follow up on your last comment. You know, you talked about the backlog. You mentioned service was up a little bit in the quarter. I mean, it's early to talk about 21, especially during the pandemic. But at the same time, you do have your specialty business that looks like it's starting to turn up. You know, and you mentioned service up and safety. So any initial thoughts about 21 and the confidence level around growth in the businesses? You know, maybe you have more confidence in one segment versus another, but any initial thoughts that you'd have?

Well, you know, we're rolling up our 2021 budget, you know, as we speak. I haven't seen, you know, really any of those figures at this point. But, you know, we remain confident in the business model that we've put forth to you. You know, if you look at, you know, our bellwether, you know, in safety services, right, is inspections, right? And we talk a lot about how we're, you know, 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 that's what we reported at the end of the second quarter in the call as well. And so we've maintained that through the third quarter, you know, in the middle of the pandemic. And so we believe that that continued focus and growth in service is going to, you know, bear well for the business as we move into 2021. And our mechanical services businesses, you know, should see a resurgence in some of their work activities that were delayed as we went through the course of this year. We've talked a lot about specialty services being acyclical, and I think that those comments are accurate, and they're proving to be accurate, and we're very confident as we move into fiscal 21.

Great. And you already talked about the temporary benefits sort of rolling off here. But even if I excluded $13 million of benefits, you still did almost 11% adjusted EBITDA margin. So, look, I know you don't want to reset, you know, your margin target. But as we go into 21, is it possible to tell us or give us color on how much structural costs maybe you've taken out of the business or, you know, versus, you know, we know you have things like, you know, ERP implementation, back office consolidation. So have you just been able to accelerate that more than you thought during the pandemic?

I'll let Russ answer that, but you're right, Andy. We're not going to change our rent crew goals.

It's a nice short answer, Jim, but any other comment?

Go ahead, Russ. Well, I mean, you know, there's puts and takes, right? And when you think about it, you know, as we continue to, you know, bring these costs back, we are also incurring some additional costs as it relates to becoming a public company. And so, you know, we have to, you know, manage those expenses, you know, as well and need to include those, you know, in our forecast as we move forward. So it's not a one-size-fits-all. It's not just, you know, the expenses that were taken out, you know, in the individual businesses. So you have to look at it on a more macro basis. So, I don't know, Tom, do you have anything to add to that? No, I think you said it well.

And then, Tom, maybe one quick follow-up for you on free cash flow. Obviously, good performance, 110% of EBITDA almost this year. Is Q4 conversion still expected to be pretty good? I mean, seasonally, I would guess it would be relatively strong. And, you know, is there any way to highlight how much 2020 has been unusual for you? Because, obviously, we know your target is 80%.

Yeah, well, it has been unusual. I think the way to think about how it's been unusual, if you just kind of take a look at the drop in AR, that's driving a big piece of that improved cash performance, and that's a direct connection to the revenue decline. We do expect fourth quarter to continue to throw cash off as it has in the past on a relative basis.

I would tell you, Andy, that we want to use some of that cash to fund working capital, which means we're putting more people to work and getting more activity within the businesses. 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't 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.

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, Andy.

Your next question comes from the line of Julian Mitchell with Barclays.

Hi, good morning. We've had some fairly long questions, so I'll try and keep it concise. Maybe the first one around the handful of acquisitions that are collectively due to close in the next couple of months. Perhaps help us understand what the free cash flow conversion profile of that sort of $25 million or so of aggregate EBITDA is, and also what's the expected three- or five-year ROIC on those various transactions?

Well, we would expect the free cash flow conversion on those businesses to be 80-plus percent. They're right down the middle of the fairway as it relates to the – to our business model. They're all focused on this recurring revenue services component. And so we would expect the cash flow conversions to be, you know, right in our target range. You know, we don't, Julian, we don't track, you know, return on invested capital. That's not a metric that we currently utilize. You know, we're focused on, you know, EBITDA and the, you know, whether that's going to be accretive to our overall margin expansion goals.

Okay, fair enough. And then perhaps my 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, the warrant conversion. So maybe help us understand, you know, let's say end of this year or early next, once a lot of those things have played, see the leverage position being.

Yes. As we look to project through the end of it, to the end of the year, you know, on our net basis, we think we'll be in kind of that, you know, 2.5 to 3 range, right in that midpoint. Kind of a good place to land.

Yeah.

And I think your question is, our long-term target leverage, as you know, is 2 to 2.5. If the other $250 million of warrant proceeds, $245 million, come in, obviously the leverage ratio that Tom outlined would be somewhat lower.

Yeah, and just, Julian, Jim, if I could just kick in on this. You know, if you think about we ended the quarter at 1.8, we'll be around the 2.5 to 3 time. That's really more of a function of the calendar that we did fourth quarter acquisitions. We fully expect to be you know, on a normalized year in that range that Martin talked about.

I see. Thank you. So the implication would be you can carry on doing acquisitions, you know, from early next year. There's no sort of digestion period or anything like that.

No, we'll be fine. We'll be fine.

Perfect. Thank you very much.

Thank you.

Your next question comes from the line of Andrew Whitman with Bayard.

Great. Thanks for taking my questions. I guess I want to start, I guess maybe on the industrial services segment, the margins were obviously quite good and not lost on anyone. I think that you guys have been focused on getting more profitable at a dispensive revenue, and that's all fine, well, and good. I think maybe the performance this quarter certainly exceeded our expectation. I was wondering, Tom, if in the quarter there's anything unusual in terms of larger projects to close out favorably 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.

Yeah, no, there was nothing unusual in the quarter from something closing out better that 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 key markets are being mostly affected by the delays today.

I would say probably healthcare in safety services is the primary place where we saw some things push out to the right. We haven't seen anything canceled, but not commercial, you know, real estate, you know, You think about the end markets that we serve, I mean, we're not in that developer-led market to any great extent. And I think that's one of the advantages that we have. That doesn't mean we don't do any commercial, you know, office work. I'd say healthcare is the primary end market. Specialty services had some of our industrial clients delay some of their outage work, if you will, maintenance outage work, whether it's a mining operation, 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 COVID outbreak in the middle of that maintenance outage that would potentially delay the startup of their facility. So we saw some delays really in both segments.

Got it. That's helpful. And then I guess my last question here is, is just regarding 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 a historically North American-focused company, got comfortable with certainly the same types of businesses, but really in new markets and the new market dynamics that come with different cultures, different regulations, different labor rules. and certainly probably a different customer set, a similar customer type, but different customers themselves. All those things are important, I think, 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 comfortable with us in this deal.

Yeah, so we have a business that's based in the U.K., that, you know, we've had for a number of years. And we've always had some interest in, you know, continuing to grow, you know, our platform in the UK and in Europe in general. And so, you know, SKG, you know, was 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's great synergy between the services that we provide and our safety services. And, you know, we've already started to collaborate with the SKG team and our safety services team on this. how can we leverage our spend with our vendors and so on and so forth. So I don't look at SKG as a stretch or a reach for us by any stretch of the imagination. It's not a huge business. It's not a big business. We really like the leadership team there. They're rock solid. And I think it's right down the center of the fairway. So And then, you know, the other part of it is that, you know, Martin Franklin is involved with Nomad Foods, and so they've already got a tremendous amount of experience in the European markets that we're going to be able to lean on in addition to the experience that we have in, you know, 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 to SKG, and we think that's going to be a great platform for us to move forward with. Great. Thanks a lot.

Andrew, we'll see you at your conference tomorrow. I'm just going to tee up, you know, as we're talking about acquisitions, and since we have Martin on the phone, you know, a lot of people have asked us about multiples that we've paid. But, Martin, do you want to give some color just on how we're thinking about acquisitions and multiples?

Yeah, sure. I mean – You know, as you probably, you know, investors who sort of know the space and are familiar, you look at some of the other service companies that have been sold as late. You've got companies like Pybarker, ServiceLogic, companies like them that have been traded at, you know, 14 to 16 plus EBITDA multiples. You know, people who know us long enough know that that's not really our zip code. We like to trade at those levels, but we're not really buyers at those levels. We've tried to... find the right, if you like, arbitrage between small and large. And the smaller acquisitions, as I think you all know, trade in the, if you call it mid-single digit multiples, that's the norm for the smaller companies. When you get to mid-size, those multiples start moving up, as you probably saw with SKG. And I think you should use that as a model for how we look at acquisitions. Obviously, from our perspective, We look at our entry multiple and API, which, you know, has rewarded 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, tick all our boxes, and come at an appropriate valuation. So, you know, we don't use sort of one size fits all. We're opportunistic. But, you know, we think that 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 a very compelling part of the story from the very beginning for us, was 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, it's such a fragmented market, there are so many companies, you really don't need additional capital to 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. And to the extent we can create additional platforms and take ourselves into new territories, like we did with SKG, that's the strategy we're going to pursue. So expect more of the same kind of philosophy going into the next, you know, three to five year program.

Operator, who's up next in the queue for questions?

Your next question is from the line of Adam Thalheimer with Thompson Davis.

Hey, good morning, guys. Congrats on a great Q3. Thank you.

Good morning. Good morning. Can you give us a little more color in the safety business? I'm surprised the revenue is 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. I'll let Rose answer the first part.

Well, I mean, it's not 100 – you know, there's – we have mechanical services inside safety services as well, and that's where the primary impact was. We also have a – you know, we have certain locations that were impacted by COVID more so than others, and – So, you know, there is an element of looking at it from a geographic basis as well. You know, there's markets like, think about New York and the impact that New York had compared to the rest of the country and their ability to recover and get back on a more normal cadence. So, you know, like we track man hours by week for every single one of our companies. And, you know, we've watched our man hours kind of, Tick up, tick up, tick up, and tick up. But certain marketplaces have had slower, you know, 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 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, you know, specifically like Toronto went into, you know, a greater level of lockdown, you know, than some of the other markets. And it's the same thing. We're watching those hours kind of pick back up and get back to a more normal place. And so it varies by business. And so you have to make decisions, you know, based on the variability in each one of those businesses and how you react and respond. Okay. Yeah.

And, Russ, it's probably way too early, but there was a school of thought that 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 I guess now we have positive vaccine news. It's probably way too early, but, I mean, are you seeing an uptick from those events?

Well, I think it's much too early. I mean, you know, the vaccine is not going to be readily available to, you know, everyday America for a number of months. And so, you know, we are looking at our business and we are continuously planning, you know, like there's the second wave and what's going to happen, you know, what is your plan so that you can respond and react. And we expect that things are going to change again by markets. You know, so like if you look – If you look at it, like yesterday, the governor of Minnesota came out with more restrictive, you know, actions because of COVID. Now, I don't think it's going to affect our business at all. But, you know, you have to continue to, you know, 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 we are proactive and we are going to, you know, manage our individual businesses based on the situations and the conditions that we're faced with. But I think it's too early to tell. Our backlog is solid. I mean, that gives us great confidence as we move into 2021, you know, and beyond. But you know, Like, I call it productive paranoia, and it means, you know, it's like always, you know, keep one eye open in the back of your head to make sure that you're in a position where you can respond to the conditions that you're faced with.

Yeah, good job on flexing, yes. The EBITDA margins in light of the top line are very impressive.

Who is – You know, one of the things that you have to also think about relative to the election, and I'll just call it, you know, relative certainty as we head into next year, as Russ mentioned on the call, you know, there are infrastructure opportunities for us, both in safety and in the specialty services business. If 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's hell wind if it happens.

Understood. Thanks, guys. Thank you. Thank you.

Your next question comes from the line of Catherine Thompson with Thompson Research.

Hi. Thank you for taking my questions today. And I appreciated the color on the multiples with acquisitions. That was actually the part I was going to hunt down. So thanks, James, for that. But following up on your three remaining acquisitions that you're going to be closing this quarter, could you give a little bit more detail, just a bigger picture in terms of the strategic thinking of how these companies fit into the growth trajectory for the company? And then also, you know, I understand that many are just part of the bigger picture, but really want to be able to think. Because when you explain these three, it gives a richer picture of, how you're thinking strategically going forward. Thank you.

Thanks, Catherine, for your question. Thanks for participating in the call today. We appreciate it very much. So I would tell you that all three of these transactions are geographically complementary 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 acquisition in specialty services, again, is geographically complementary to our existing business. So that's one key driver for us. They're all focused on service and the recurring revenue component of service. And so 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 just a great opportunity for us to add quality people to the API family. The thing that we know is that, you know, from an operational, when we think about it from an operations perspective, we know that through our strength in buying today that we can help improve those businesses, their results from day one. And so there's just a tremendous amount of opportunity for us to continue to do it. You know, in the call today, we talked about, you know, some of our corporate clients, and we talked about, you know, having 200-plus locations across really North America, and we need to continue to expand on that, especially in safety services as we continue to put, you know, more geographic, you know, I'll just call it thumbtacks on the map, if you will. The better we're able to service our corporate clients, from an inspection perspective across the U.S. and Canada. So these businesses all fit right into our sweet spot and what we're trying to accomplish.

Okay, thank you. And then just following up on the margin color you gave, I appreciate that there is a mix between a greater service and also improved efficiencies. For the quarter, at least, could you help us parse out in greater detail how much of it was Mix versus efficiencies and cost-cutting measures. You talked about it generally, but it would be helpful to say, well, listen, half of it was mix versus, and the other half were cost-cutting.

Yeah, I think you're directionally right there. It's very difficult for us to have that information any tighter than what you've described there. It's a combination of many levers. There's a little bit of pricing improvement that we had. There was a little bit of better execution. We're in a time with COVID that we have some instances that we can get to places quicker because there's less cars on the road, but then we have an offset to that where we can't put two people in a truck to go work on a project, so we've got two vans going. So it's a little mix of everything, but I think directionally it's 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 it leads into my last question for the day. There's been a great deal of focus on project selection and reducing your loss rate overall. Could you give an update just in terms of how these best practices towards that goal are being implemented across the the organization, and then what is the ultimate goal in terms of the margin upside to this specific initiative? And just final point for that, where are you today versus a year ago in this journey?

So I would share with you that we've gained on it. And, you know, we shared, I think, that we had a contract loss rate of 1.5%. Last year, we have set a goal this year to reduce that by half, and we've gained on that. We're not 100% there, but we've gained on it. Now, just do the simple math. I mean, if it's 1.5% and we get to zero, you've got a 1.5% gain. So, I mean, you can figure out how that impacts our margin, you know, just intuitively. Right. It should be zero. And that's what the goal is. 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, you know, a process, so to speak, a notification process, for larger opportunities for the company. But we've really instituted a much more disciplined go, no-go checklist that is actually an app that people have on their devices that they go through to, you know, before they even submit or put a pencil to paper as it relates to preparing a proposal for their clients. 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, you know, $15 million of opportunity inside it that are all, you know, $50,000 opportunities that roll up to this large master service agreement, it comes across my desk and I see it. And so, you know, it's, I guess, bringing more discipline to our business as it relates to Who do we want to work for? And in almost every situation, Catherine, it comes down to really who's the customer, and we want to make sure that we're being really selective in who we're working for.

And, Catherine, it's Jim. You know, very good question. It's all part of our path to the 12% plus. You know, we don't have any home runs built into this. It's 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, Catherine, I don't mean to cut you off, but we're a little bit over the time. We have CJS out there, which, as everybody knows, was the first guys to launch coverage on us. And so I think we should end with them, let them get their question in. But I know you guys have other calls, and we have calls with investors. So if we have John and CJS.

Yes, one moment. And John's line is open.

Hey, guys. Thank you. Thank you for letting me on. We really appreciate your support. A lot of my questions have been answered, and I know we're short on time, so I'll just keep it to one. Just wanted to drill into SKG a bit. I was wondering, first, what was the contribution you're expecting in your Q4 guidance from SKG?

It's about a penny and a half or about $4 million in EBITDA. You can call it $40 million in revenue.

My apologies, John's line has disconnected.

Well, I guess everybody heard my answer to John's question. I'm not sure if John heard it. But with that, why don't we wrap it up? Russ, do you want to close us out?

No, yeah, Jim, I would. 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 API. We're very proud of where we're at today. It's been a long journey, you know, for the first year of being a public company amidst the pandemic. But we have a great team at API. I'm very proud of our people and 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, everybody.

Thank you, ladies and gentlemen. This concludes today's conference call. We thank you for participating and ask now that you could disconnect your lines.