APi Group Corporation

Good morning, ladies and gentlemen, and welcome to API Group's third quarter 2021 financial results conference call. All participants are now in a listen-only mode until the question and answer session. Please note, this call is being recorded. I will be standing by should you need any assistance. I will now turn the call over to 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 2021 earnings conference call. Joining me on the call today are Ross Becker, our President and CEO, Kevin Crum, our Executive Vice President and Chief Financial Officer, and Sir Martin Franklin and Jim Lilly, our Board Co-Chairs. Before we begin, I would like to remind you that certain statements in the company's earnings press release announcement and on this call are forward-looking statements, which are based on expectations, intentions, and projections regarding the company's future performance, anticipated events or trends, and other matters that are not historical facts. These statements are not a guarantee of future performance and are subject to known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. In our press release and filings with the SEC, we detail material risks that may cause our future results to differ from our expectations. Our statements are as of today, November 10th, 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 financial performance on the investor relations page of our website. Our comments today will also include non-GAAP financial measures and other key operating metrics. The reconciliation of and other information regarding these items can be found in our press release and our presentation. In addition, please note that the company no longer adjusts gross profit, selling general and administrative expense, and net income for depreciation remeasurements associated with acquisitions. The prior comparative periods have been recast to reflect the updated presentation. There is no impact on future periods as the actual and adjusted amounts are approximately the same for the fourth quarter. The supplemental information is available in the presentation section of our website. It is now my pleasure to turn the call over to Martin.

Thank you, Olivia. We had another very productive quarter, and I might add a very busy one. Over the last 90 days or so since our last earnings call, we announced the planned acquisition of the Chubb Fire and Security business, and add on to our term loan facility an equity offering, and completed a very successful bond offering. Each of these capital markets activities gave Russ, Jim, and I, and now Kevin, the opportunity to update current investors on the business and introduce new investors to the company. We will welcome three new Bulge Bracket firm analysts to all of you as they launch coverage in the company in the coming months, as we continue to widen the audience and network of API investors. Having recently passed our two-year anniversary since completing the acquisition of API on October 1st, 2019, we're very pleased with the progress achieved at the company. while also being very focused on the future with the upcoming strategic acquisition of Trump. The Trump acquisition will open another new chapter for API. However, we also see it as a continuation of our original investment thesis in the value of creating the global leader in life safety services, concentrating the majority of the business on statutorily mandated recurring revenue services. Russ and Kevin will speak to the performance of the business, but I would add that in our view, the strong performance of the business speaks to the leadership team, discipline of the organization, and the future opportunities for API as we continue our focus on shareholder value creation. We believe we have strong momentum and a clear path to make the most of the opportunities in front of us. Russ and his team are doing the right things internally to build on our already solid foundation for a very bright future. With that, I'll hand the call over to Russ.

Thank you, Martin, and good morning, everyone. Thank you for taking the time to join our call this morning. As you heard from Martin and saw from our press release on September 8th, We're all delighted to welcome our new Executive Vice President and Chief Financial Officer, Kevin Crump, to API's senior leadership team. He is the right person at the right time for API as we continue our evolution and our growth as a public company and plan for the acquisition and integration of the Chubb business around year end. Kevin's deep operating and public company finance background, including substantial international and integration experience, is being immediately leveraged as API begins the next leg of its journey as the world's leading life safety services provider following the acquisition of Chubb. As Martin said, we had another very productive quarter. From the announcement on July 27th of our entry into an agreement for the transformational acquisition of the Chubb Fire and Security business to the completion of our common stock offering on September 17th and the expansion of our leadership team, this was an act of three months in addition to executing on our ongoing business operations and delivering solid operational performance. Despite all of that activity, the safety, health, and well-being of all of our leaders remains our number one priority. Before we provide you with a summary of our strong third quarter financial results, our positive outlook, and an update on the acquisition of Chubb, I would like to start by thanking our team for all of their hard work to support the ongoing evolution of the business. I am pleased with our continued ability to execute in the third quarter amidst ongoing supply chain disruptions, inflationary pressures, and continued COVID-19 impacts. While supply chain disruptions and modest inflation cause some downward pressure on margins, as expected, our proactive approach to mitigating the impact through measures such as pricing, combined with our disciplined approach to project and customer selection, and the strength of our recurring revenue, services-focused business model yielded results. As we look to the future, we believe the company is well positioned to achieve our long-term goals. Our backlog is at an all-time high, and we have seen increases across all three of our segments relative to prior year levels. Backlog is up more than 20% for our safety and specialty services segments. We continue to see strong demand across our key end markets, such as data centers, fulfillment and distribution centers, healthcare, and high tech. Last Friday, Congress agreed to an infrastructure spending bill. We expect this to be a net positive for us. As we have said on past calls, we do not have anything built into our budget for an infrastructure bill or stimulus that would incentivize investment in the renovation of existing infrastructure. We do expect certain aspects of our business such as 5G fiber, renewable energy, water and gas services to benefit due to existing core competencies combined with incremental opportunities. As we move through the balance of the year and into 2022, we are closely monitoring supply chain constraints, inflationary pressures, and vaccine mandates, and we'll remain proactive in our approach to mitigating risks through pricing and appropriate contract language for proposals. We remain focused on achieving continued success within our existing core businesses and are also spending a considerable amount of time planning for the opportunities 2022 and beyond will bring. As part of our annual budgeting process, we challenge each of our operating companies to develop a long-term plan that addresses the opportunities as well as any potential challenges unique to their market and operations. These plans are reviewed during strategic planning sessions with our segment leaders and include a detailed roadmap for organic revenue growth and margin expansion opportunities to drive towards our goal of achieving an adjusted EBITDA margin of 13% by 2025. These include the following key initiatives as outlined at our investor day in April. First, improving our mix. We have a relentless focus on growing recurring inspection and service revenue. We are on track to achieve our goal of growing inspection revenue by 10% plus in 2021. Two, disciplined project and customer selection. Our contract loss rate continues to improve. We have made significant progress towards achieving our target of 0.70% or less in 2021. We will continue to resist lower margin, higher risk activity. Third, continued focus on pricing opportunities. Fourth, leveraging SG&A and cost of goods sold through areas such as shared services and procurement. Kevin will provide an update on our business process transformation efforts later in the call. And fifth, and lastly, operational excellence. As many of you heard me say previously, there isn't one part of our business that couldn't be better. Before turning the call over to Kevin to cover our results and outlook in more detail, I'd like to spend a few minutes providing an update on our previously announced acquisition of Chuck. Since announcing the transaction, which remains on track to close around year-end, the level of excitement from our international customers and our teams about the opportunities the combined platform will bring has continued to validate our belief that the transaction will be highly accretive with compelling synergies, that it will complement revenue growth through cross-selling certain products and services, and that the opportunity for margin expansion is meaningful. Most importantly, we couldn't be more excited about the prospects of working with such a talented international leadership team that carries the same values and focus we do at API. As discussed on our last earnings call, similar to API, Chubb is a people-centered business. In a people-centered business, individual growth, both personal and professional, is a key ingredient to our long-term success. We intend to leverage the best practices of both organizations across all aspects of the business and look forward to creating an environment in which the combined 26,000 employees can continue to grow and flourish. We believe great leaders are a competitive advantage and drive shareholder value creation. We have dedicated teams working intently on the integration. You may have seen our press release on September 8th announcing senior leaders in charge of aspects of the integration. These teams are just a few of the many people focused on each functional area of the business working with their peers at Chubb planning the integration. Kevin and I spent last week getting a first-hand view in London with the Chubb team and going through transformation plans designed to achieve our 2025 goals, after which we will then set new and higher goals. We look forward to providing more detail on our plans to drive operational improvements and capitalize on the synergies that exist between the two businesses after the transaction is closed and budgets have been finalized. In summary, I'm very pleased with how the business has performed this year and how we are dealing with the challenges and opportunities before us. I'm excited to have Kevin on our team and I'm excited about the momentum we have in the business. I would now like to hand the call over to Kevin to discuss our financial results and Outlook in more detail. Kevin?

Thanks, Ross. Good morning, everyone. I'm excited to be here today for my first earnings call since joining API on September 20th. I'll begin my remarks by reviewing our consolidated results, followed by a discussion on our balance sheet position and segment-level operating performance before turning to our Outlook. I will conclude by providing a brief update on our business process transformation efforts. Net revenues for the three months ended September 30, 2020, increased on an organic basis by 13.4% compared to prior year. This is excluding industrial services. For the nine months ended September 30, 2021, net revenues increased on an organic basis 12% compared to the prior year. Again, this is excluding industrial services. Adjusted gross margins for the three months ended September 30, 2021 was 24.3%, representing a 34 basis point increase compared to the prior year, driven by outsized growth in our higher margin safety services segment and improved mix of inspection and service revenue. This was partially offset by expected supply chain disruptions and modest inflation, which is causing downward pressure on margins. For the nine months ended September 30, 2021, adjusted gross margin was 23.7%, representing a 50 basis point increase compared to prior year due to the items mentioned as drivers for the third quarter adjusted gross margin. Adjusted EBITDA margin for the three months ended September 30, 2021 was 11.9%, relatively consistent with prior year, so driven by outside growth and the higher margin safety services segment and an improved mix of inspection and service revenue. This was partially, or this was offset by continuing supply chain disruptions, modest inflation, which is causing downward pressure on margins, as well as less contribution year on year from joint ventures and our specialty services segment. For the nine months ended September 30, 2021, adjusted EBITDA margin was 10.3%, representing a 28 basis point decline compared to prior year due to the items mentioned as drivers for the third quarter EBITDA margin. Adjusted earnings per share for the three months into September 30, 2021 was $0.35, which excludes a positive impact of $0.02 due to the discontinuance of the depreciation remeasurement adjustment Olivia mentioned earlier in the call. We continue to focus on driving strong free cash flow, and our balance sheet and liquidity profile remain strong. As we commented on last quarter, our substantial growth in organic net revenues has required increased working capital investment on a year-to-date basis as we ended Q4 2020 with suppressed working capital levels. For the nine months ended September 30, 2021, adjusted free cash flow was $85 million, representing a $216 million decrease compared to prior year, and our adjusted free cash flow conversion rate was approximately 29%. Our cash flow performance on a year-to-date basis was in line with expectations and our historical trends as we continue to build working capital from our reduced prior year base. We expect to generate additional adjusted free cash flow in the fourth quarter to arrive at an adjusted free cash flow conversion rate for 2021 of around 70%. As of September 30, 2021, we had $1.1 billion in cash and cash equivalents and no outstanding borrowings under our $300 million revolving credit facility. We expect to be at a pro forma net leverage ratio of 4.1 times at closing of the Chubb transaction with the goal of returning to below three times net leverage expeditiously. Our near-term focus remains on closing the transaction and then deleveraging by approximately one turn annually. We'll do this through the high free cash flow conversion offered by our combined asset light operating model, and we will do this while continuing to invest in our leaders and business process improvements. I will now discuss our results in more detail for each of the three segments, beginning with safety services. Safety services net revenues for the three months ended September 30, 2021, increased on an organic basis by 22.8%, primarily due to continued growth in inspection and service revenue across the majority of our markets and general market recovery compared to the prior year period, which was negatively impacted by the pandemic. For the nine months ended September 30, 2021, net revenues increased on an organic basis 15.5% due to the items mentioned as drivers for third quarter organic revenue growth. Adjusted gross margin for the three months ended September 30, 2021 was 31.7%, representing a 97 basis point decline compared to prior year periods driven by certain supply changes or disruptions resulting in a decline in productivity. This was partially offset by an improved mix of inspection and service revenue. For the nine months ended September 30, 2021, adjusted gross margin was 31.7%, which is relatively consistent with prior year adjusted gross margin of 31.6%. Adjusted EBITDA margin for the three months ended September 30, 2021 was 14.3%, representing a 183 basis point decline compared to the prior year due to the return of largely temporary cost containment efforts implemented last year to counteract the negative impact of the pandemic. This was partially offset by an improved mix of inspection and service revenue. For the nine months into September 30, 2021, adjusted EBITDA margin was 14.2%, representing a 40 basis point increase compared to prior year due to an improved mix of inspection and service revenue. This was partially offset by the return of largely temporary cost containment efforts implemented last year to counteract the negative impact of the pandemic. I'm now going to discuss the results for our specialty services segment. Specialty services net revenues for the three months ended September 30, 2021 increased on an organic basis by 9%. This is primarily due to the increased demand and timing for our specialty contracting services. For the nine months ended September 30, 2021, net revenues increased on an organic basis by 11.7% due to the items I mentioned for the third quarter with third quarter organic revenue growth with weather being an additional headwind to the business in Q1, 2021. Adjusted gross margins for the three months ended September 30, 2021 was 17%, representing a 78 basis point decline compared to the prior year due to expected supply chain disruptions and modest inflation, which is causing downward pressure on margins. This was partially offset by an improved mix of service revenue and disciplined project and customer selection. For the nine months into September 30, 2021, adjusted gross margin was 15.4%, representing a 37 basis point decline compared to the prior year due to the items mentioned for the third quarter, along with lower productivity due to unfavorable weather conditions faced in the first quarter of 2021. Adjusted EBITDA margin for the three months ended September 30, 2021 was 12.4%, representing a 186 basis point decline due to the items noted for gross margin performance, along with the return of largely temporary cost containment efforts implemented in the prior year to counteract the negative impact of the pandemic and less contribution from joint ventures compared to the prior year period. For the nine months into September 30, 2021, adjusted gross margin was 10.6%, representing a 143 basis point decline compared to the prior year due to the items mentioned for third quarter adjusted EBITDA margins. I'll now discuss results for our industrial services segment. In industrial services, net revenues for the three and nine months ended September 30, 2021 declined on an organic basis by 33.3 and 49.6% respectively. The decline was driven by our continued focus on discipline project and customer selection, decisions by our customers to delay and suspend certain projects, as well as difficult industry conditions. Adjusted gross margin and EBITDA margin for the three months ended September 30, 2021 was 10.7% and 8.7% respectively. This was compared to 16.3% and 14.4% respectively in the prior year period. The decline was driven by unabsorbed cost for leases and equipment. This is due to lower volume. This was partially offset by improved mix of our service revenue. For the nine months into December 30, 2021, adjusted gross margin and adjusted EBITDA margin was 5.6% and 2.6% respectively. This was compared to 16.6% and 13.8% respectively in the prior year period. The decline was due to the items I've noted for the third quarter gross margin performance. I'll now move to our 2021 guidance. Our full-year revenue in adjusted EBITDA for 2021 remains unchanged and does not reflect any contribution from the upcoming Chubb acquisition. We continue to expect adjusted net revenues for 2021 of between $3.65 billion to $3.75 billion with continued growth in the fourth quarter and adjusted EBITDA for 2021 of approximately $405 million. We continue to expect capital expenditures to be approximately 55 million. We expect depreciation to be approximately 75 million. which includes 15 million related to the recast of comparative periods previously adjusted, as mentioned earlier on the call. Our cost of capital is approximately 5%, our adjusted mid and long-term effective tax rate remains approximately 21%, and our estimated adjusted diluted weighted average share count for 2021 is approximately 211 million. As a reminder, the adjusted diluted weighted average shares outstanding for the third quarter is 210 million. Before turning the call over to Jim, I'd like to provide a brief update on our multi-year business process transformation project. This includes ongoing efforts to further tie our technology platform with improved business processes, which we expect will allow us to move towards a true shared service model and ultimately allow for better leveraging of our SG&A. This also includes efforts to further leverage purchasing and procurement scale to drive margin expansion. This is one of the contributors to our adjusted EBITDA margin expansion goal of 13% by year end 2025 mentioned by Russ earlier in the call. The process as outlined at Investor Day in April continue to move forward as planned. We are pleased with the continued progress we've made as the overall plan is largely on budget and delivering key milestones in line with the deliverable schedule that was established at the start of the project. We're making gradual improvements in the business that will allow us to enjoy the benefit for many years to come. As we go through the planning, budgeting, and integration process with Chubb and gain a better understanding of their needs, we will reevaluate and re-scope the business process transformation project to ensure that we remain thoughtful and flexible and incorporate Chubb's needs. We intend to take advantage of the investments they've made so that in the end we have a meaningful, global, one-company, go-forward plan. We look forward to updating you on this and all of our projects in 2022 once the Chubb transaction has closed. I'll now turn the call over to Jim.

Thanks, Kevin. We believe that the company is operating well in this environment despite some of the supply chain disruptions and inflationary cost pressure we've seen in the industry. Fortunately, API has more tools to mitigate these issues than some businesses that have longer contract durations than ours and have more exposure to inflation. While API isn't immune to what is occurring in the marketplace, we do believe we have certain competitive advantages that protect and drive shareholder value. Our team has always been a cost-focused culture, and they are skilled at proactively and preemptively minimizing these negative effects. As we've stated previously, the average size of our projects, including all three of our segments, is less than $100,000, which helps to limit our exposure to increases in raw material costs. In addition, the average duration of our projects is less than six months, so we have less inflationary exposure to cost of goods sold or changes in labor expenses than others may experience in an inflationary environment. Our pricing is very much real-time pricing, as our visibility curve is very clear as we are quoting projects that are occurring in the near term. We believe that these are competitive advantages that allow us to stay focused on real-time pricing and operational efficiency to ensure true costs are reflected in each project that we take on. The Chubb Fire and Safety and Security business has a similar profile, and we believe it will enhance our overall position rather than detract from it. It's also very gratifying to see strong underlying demand for our services as reflected in our organic revenue growth in our core business segments and the elevated year-over-year backlog across all three of our segments. This has given us momentum in the third quarter and provides us momentum as we move into the fourth quarter and plan for 2022 and the acquisition and integration of the Chubb Fire and Security business. We're very excited by the near-term and long-term opportunities for API and believe there is significant future value creation as we combine our two organizations and realize revenue as well as cost synergies. As you've heard from all of us, we have great confidence in the business and the direction we're heading, and we look forward to reporting on our continued progress as we continue our focus on driving shareholder value. And with that, I'd like to go back to the operator and turn the call open for Q&A. Operator?

At this time, if you would like to ask a question, press star 1 now on your telephone keypad. Again, that is star 1 on your telephone keypad. To withdraw yourself from the queue, you may press the pound key. We'll take a question from John Tanuantang of CGS Securities.

Hi, all. Good morning, and thank you for taking my question. Kevin, congrats on the appointment. My first question is actually for you. I wanted to circle back on the depreciation item you and Olivia mentioned earlier in the call. Is that purely an accounting change with no cash impact and, furthermore, on an apples-to-apples basis? What would have your adjusted EPS or net income have been compared to prior periods if that was a consistent item?

Yeah, it's an accounting change. I can answer that. Thank you, John. And it is – It is also a non-cash impact, so it doesn't affect our adjusted cash. I referenced it earlier, so it had a two-penny impact on us by removing it in a quarter.

So, John, that would have been 37 versus the 35.

Okay, great. Thanks for that, Cutler. And then more broadly, I was wondering if you guys could comment on the M&A environment. My understanding is that one of your peers, ServiceLogic, traded hands between private equity for a pretty big premium. You know, you obviously have a record for acquiring smaller assets in the mid-single digits, EBITDA, you know, Chubb and SK and the low teens. Can you help us understand how you're able to ink these deals at substantially lower multiples and, you know, for these assets, especially, you know, given the current environment and what private equity is paying for these things these days?

Yeah, so, John, I mean, well, first I would start by saying that, you know, we did take a slight pause in our kind of our bolt-on M&A strategy as we went through all of the financing activities associated with Chubb. That was a very thoughtful decision on our part and something that we felt was the most prudent thing for the business. But we have a very robust pipeline. of opportunities that we're continuing to evaluate. We've, so to speak, restarted the engine and we still see opportunities in that four to six times range. I would say that the difference for us is that we feel that we have a very compelling story to tell that we are a very attractive home for many of these smaller family-owned businesses that are looking to sell their company and sell their company not only to help them with a long-term exit but also find the right place for their employees and so we like our story and we still see the the opportunities for us to acquire businesses in in the in that four to seven times range

I'd also add, Martin, that you're right that we've been seeing some of the larger transactions particularly in the United States, going in the high teens and almost to the mid-20s of EBITDA multiple. We're clearly not going to play in that space, but in terms of comparative value, it validates, I think, our thesis and our discipline in looking for opportunities that can be scaled, like Chubb. where, you know, we're in a unique position as a buyer and we feel we can get value at multiples that I think are much more palatable than some of the deals that are going on in this environment. So, you know, we're going to stay disciplined, but there are definitely opportunities out there in the Tuckin world with the original formula that API successfully executed, but it does encourage us in terms of what the comparative multiples should be over time for us as a larger public company.

Got it. Thanks, Russ and Martin. And just last one from me. Russ, I know I've asked this a couple times in prior calls, but now that the infrastructure bill is passed on to us, you know, to a much more later stage where it's likely to be signed into law. At this point, is it prudent to start budgeting for it, or do you need to see it, you know, signed first and wait for your customers to announce what their plans are before you start thinking about what the impact could be?

Yeah, so, I mean, you know, there's a lot there, John. You know, first I'd start by saying a rising tide floats all boats. And, you know, the infrastructure bill will certainly have a positive impact on the industry in general. It will take time for some of the spending programs to actually become a reality. And, you know, we will, you know, factor those opportunities, you know, into our plans. as we gain additional visibility. There's a few buckets that are interesting and potentially can directly impact us. As an example, there's roughly $65 billion for broadband internet that would increase access for rural low-income communities. In tribal communities, we see an opportunity in that space. There's also approximately $55 billion for potable water infrastructure that would have a positive impact, you know, on aspects of our business. So there's some places there that we see that will ultimately be positive for the company, but we won't factor that into our plans until, you know, we have more clarity around the reality of the work programs actually happening. Okay, fair enough. Thank you, guys.

Thanks, John. Thanks, John.

Our next question is from Marcus Mittermeier of UBS.

Hey, Marcus. Hi. Good morning, everyone, and welcome, Kevin.

Thank you.

One on margins, if I could. Russ and Kevin, you mentioned, obviously, supply chain and insulation pressures. understand the point around small project size and short duration but can you elaborate a little bit on sort of like where you saw that downward pressure how much pricing you were able to um you know, put through and what that then means for backlog margins, right? You kind of set 20% up in terms of backlog and safety. Should we assume that margins, they are protected? I'm just trying to reconcile a little bit that you held cross margins, obviously, relatively stable, but there seems to be some movement here or pressure on the segment margin. Is that all that cost coming back that you alluded to? Is there some inflation in that as well? Just if you could elaborate on that, that would be great.

Yeah, sure. Marcus and good morning and thanks for participating today. So, you know, I guess there's a few things there. I like to separate the supply chain disruptions from some of the inflationary cost issues that we're seeing in the business. And as it relates to the supply chain, the where the margin pressure comes in is. that it makes it more difficult for us to be efficient and productive in the execution of our work. So it's not necessarily price related, it's productivity related in being efficient as we execute our work plans. And oftentimes it's not even necessarily associated with us. If somebody that is working in front of us has supply chain issues and we've done a great job of managing our supply chain, they can have a negative effect on the efficiency of our workforce. And so we have to be very proactive from that standpoint. Regarding the inflation, I'd be a liar if I told you that we didn't see some negative impact from rising steel prices and such. But I would point you to the low average project size of the work. If you look at safety services, our average project size is $10,000. Our specialty services, our average project size is $70,000. And so the work programs that we have are really quick turning, quick hitting, short duration. And we're able to factor in that cost escalation for the most part. you know into our pricing you know as we continue to move forward so I feel good about you know the integrity of the margins in our backlog Marcus I think we've done a really good job of communicating you know with our businesses and in some of our larger you know installation work that we have for our service customers we have built in price escalation and protection from rapid price escalation from a contract language perspective. And I feel like we've done a really nice job of staying out in front of it and communicating with the businesses to make sure that they're well protected from any sort of price increases.

That's helpful. Thank you. And for my second one, more long-term right now with a few more months looking at jobs, I know that the 13% target that you have is for, you know, old API, so to speak. You know, how much confidence do you have that the combined entity is going to be at these levels or maybe even higher now that you kind of looked at the asset for a few more months and sort of what are some of, you know, some examples that maybe get you excited for that opportunity? You know, if you can share anything on that would be also helpful.

So I'm very confident that our 13% EBITDA margin target for 2025 is achievable even with the Chubb acquisition. The more time that I spend with Chubb and the leadership team, with Chubb, with the people on our team, Paul Bruno, Kristen Schultes, that are really working on the integration, I get excited. There's a tremendous amount of work associated with the integration. and getting to the point where we get the transaction close, we have very good visibility into the areas of opportunity that we see that we're going to be able to, you know, really take advantage, you know, from a margin improvement perspective inside of CHUP. And like I've said in previous calls, like, I really feel like this is the center of the fairway transaction for us. This branch-led ownership at the branch level model is exactly how we've built API, and that's how we're going to really truly transform the performance of Chubb, is working directly with their leadership and improving the performance of the individual branches while we're taking advantage of procurement in other areas that we can really focus on enhancing the margin profile of the company. So I'm greatly confident.

Thank you. Thanks, Marcus. Our next question is from Andy Whitman of Baird.

Great. Good morning. Thanks for taking my questions, guys. I have a few of them here, and I just thought I'd start out by asking about the guidance and the implied fourth quarter guidance in particular. I think it's fair to say that the revenues in this quarter, like you pre-released, were trending at the high end of analysts' expectations. It seems like, you know, the backlog is clearly should be supportive here. It feels like the revenue guidance in particular screens as a little bit conservative. Am I thinking about that the right way?

Hey, Andy, it's Jim. I think consensus out there right now is at the high end of the range that we gave, which implies around 6% or 7% growth. And, you know, we've got your conference, we've got other conferences. October is just behind us. You know, we may give an update later in the quarter. But, you know, we're comfortable with where consensus is right now, which is, you know, that towards the higher end of the guidance we gave. So I wouldn't worry about... where the numbers are. If you look at the words and listen to what we said, we're very comfortable with the momentum that we have in the third quarter and that coming into the fourth quarter and the momentum carrying in. And if you listen to what Russ said about the backlog, but, you know, we like to under-promise and over-deliver, and we just don't want the world getting too far out in front of us.

Got it. Fair enough. I thought I'd ask my next question on free cash flow. And I guess you did say kind of what the number was going to be for the year. And it implies a pretty big fourth quarter. So I guess maybe a two-part question maybe for Kevin would just be like, you know, the working capital seems like it was a pretty significant draw here in the third quarter. And just is there anything that we should know that's inside that, any customer disputes or other things that slow down collections there that happened in the quarter? And then maybe talk a little bit about the visibility you have into that fourth quarter, given its implication that it's a pretty big quarter for cash.

Yeah, hi Andy, thanks. So a few things on cash flow. Just as a reminder, our base year last year was an anomaly for us from a free cash flow conversion standpoint. We ended the year well above 100%. It's also important to note that Q4 is usually our largest free cash flow quarter in any given year, and we expect it to be that this year too, especially as we come off of our highest revenue quarter, which is So all that said, we ended last year Q4 with suppressed levels of working capital just because of where we were in the year with backlog and everything else. So we ended the year with really suppressed levels. We built those back significantly in the first half of the year due to the significant organic revenue growth we had. And so on a year-to-date basis, our free cash flow conversion is around 30%. This is in line with historical patterns using 2019 as a reference there. So 2019, you can probably look at it. I think we're around 30% to 40% through the third quarter. And so all that said, we anticipate Q4 this year to be our strongest free cash flow conversion quarter as well. You know we're at 30% on a year-to-date basis. We're expecting significant conversion. and Q4 as our revenue comes off those Q3 levels. And therefore, that's why we're comfortable with the guidance provided around that 70% number for the full year.

Great. Thanks for that perspective.

Go ahead. And just, Andy, we do not have any significant disputes ongoing with any of our clients right now.

Yeah, that's it. I'm sorry, Andy. Thanks, Russ, for that. We've actually seen a slight improvement in our key working capital metrics on a year-to-date basis, Andy, so at DSO and DPO.

Yeah, your model, because of the small projects, usually doesn't lend it to that anyway, but I thought I'd ask. Just maybe the last question, Russ, in your commentary, you didn't talk about labor availability, labor cost issues, changes that are happening there, given that that is a pretty important macro theme that's happening out there. I thought it would be remiss if we didn't ask about what you're seeing and how you're dealing with that.

Yeah, so I think, fair question and a very good question. I'll talk about, I guess, the cost of labor first. Reminder that the majority of our field workforce is union by nature, so we have great visibility into the wage escalation and the wage packages that our field leaders are being paid. And so we're able to factor that into our pricing, you know, as we continue to move forward, you know, really pretty consistently and constantly. We have certain pockets in certain markets where we're seeing more tightness in labor, as an example. Houston is a market that we're seeing a little bit more, you know, tightness from a labor perspective. We have a large installation facility. opportunity in northern Minnesota that we're executing on that's seen a little bit of a tightness from a labor perspective. But I'd also tell you that the investment that we make in all of our leaders, including the men and the women in the field, giving them opportunities to grow and develop as leaders and to grow both personally and professionally is a differentiator for us. And I think that one of the things that has been an advantage for us is that we've been able to retain our workforce. And to me, that's the first step that if you're going to be successful in leading your business through a tight labor market is you need to keep your best people first, and then those people will help you draw and attract additional talent to your organization. So we have our eye on it, and we continue to keep our eye on it, but we've been able to lead the business through the pinch right now.

And I would just supplement, you know, these are well-paid jobs with high-skilled people. You know, this isn't a situation of should we pay people $15 an hour? You know, these are well-paid jobs. And so, you know, you're attracting, you know, a higher caliber, if you will, different demographic that, you know, isn't a transitory workforce situation.

Might be a fair way to say it. Yeah, I mean, these people did not, there was no benefit for them to, say, go on unemployment because of the, you know, additional unemployment benefit provided by the federal government because their wage packages are well in excess of that. And so, I mean, that's been an advantage that we have as it relates to, you know, what our field workforce looks like.

Thanks, guys. Have a good day.

And just a commercial, we're looking forward to participating in that Baird conference this week.

We'll move next to Julian Mitchell of Barclays. Your line is open.

Hi, this is Kieran of Teleconner. I'm for Julian. I just had a question on industrial services. So I saw there was significant margin improvement there in the quarter. Can you help us think about what a normalized margin looks like for this business and how when you'll return to top line growth in that segment?

Yeah, so we view that the segment has, so to speak, hit the bottom of the trough and is beginning to rebound. If you recall, that is the one piece of our business, in particular, one company inside that segment that has some exposure to the oil and gas space. And obviously oil and gas is one of the sectors that was most heavily impacted by COVID. And we're starting to see, you know, our customers, you know, really their spending to increase. We're also, you know, really working hard to reposition the business to take advantage of the service side of the transmission space, which we, in our world, we call that integrity work. Transmission integrity work is government regulated, and the transmission companies have expansive spending programs, and that's really where we want to spend our time and our energy. We believe that the margin opportunity, while I don't know that it'll get back to fleet average in 2022, but we do believe that the opportunity for the work in this segment to be at or near fleet average.

Got it. Thank you. And then my follow-up question is on SKF. Can you give us an update on how the SKF integration is proceeding? Any surprises to the upside there? Is there anything you've learned that will help inform the integration of Chubb?

Yeah, so I would say that when you think about SK and from an integration perspective, if you go all the way back to a year ago when we acquired the firm, we actually said that it would be more of a reverse integration opportunity. and that we would potentially be, you know, looking at whether it made sense to put our current UK business, you know, integrate that with SK. You know, obviously with Chubb, you know, that changes, you know, the outlook and the picture, and that's something that our team is really working hard on right now, and we'll have more to share as it relates to how we're going to look at integration of SK's business with Chubb's business as we continue to build our budget and push into the first quarter of next year. There's certain aspects of SK's business that outperforms Chubb's business in the overlapping markets, and we want to just make sure that we're making the right decisions about the business as it relates to the people that are involved. And so we think that there's an opportunity for us to really, you know, the old adage of one plus one equals three. You know, we really see an opportunity as we move forward with the integration. SK's business in general has met expectations. They battled COVID, I would say, you know, it's had more impact, I guess, on their business than, say, than our life safety businesses in the U.S. But we've battled through it, and I would say that performance of the company is meeting expectations. It can always be better, and we're actually pushing them to continue to grow and execute at a higher level.

Perfect. Thank you. We'll take our next question from Catherine Thompson.

Your line is open.

Hi, thank you for taking my questions today. On just the physical materials and the procurement materials just to finish jobs, you've touched on it some in today's prepared commentary and Q&A, but if you could give an update on certain materials like structural steel and fiber optic cable that have been a little bit harder to get or at least are farther out. in terms of ability to procure. Where are we at those, and are there any other categories to keep an eye out for?

Yeah, so from a structural steel perspective, the only manufacturing business we have is a structural steel manufacturing business. And the biggest area of impact there would be in the supply of joist and deck. And joist and deck deliveries have pushed out anywhere from six to eight months. And so it makes planning, you know, be very important. You know, we're fortunate that we're able to call Amazon as a customer of ours, and Amazon has access to Joyston Deck products. like nobody else does. And so that's been an advantage for us in that business, and we've been able to continue to work our way through it. Steel pipe prices is probably the biggest area that we've seen rapid escalation. I want to tell you that pipe prices from the beginning of the year to today are probably up 250% or so. I'm just going by the back of my memory there, Catherine. But again, I would just point you to the fact that our... the short duration of our jobs, we're able to pass on those increases to our customers pretty efficiently. But that's probably the area that we've seen the greatest level of cost increases in steel pipe prices.

Okay. And just to follow up on labor, understanding that the majority of your labor is union, and you could have up to five years visibility for steel, for certain key metrics in terms of wages, but what type of feedback or pushback are you getting from unions in terms of coming back and saying, listen, we're in unprecedented times and we may need to readdress this? What, if any, type of conversations are you having on that labor front of readdressing already set conversations?

Yeah, so we haven't had anybody come back to us. To my knowledge, we haven't had anybody come back to us and ask us to reopen any sort of collective bargaining agreement that's already been resolved. We just resolved, or I don't know if resolved is the right way to put it, but we just recently settled one collective bargaining agreement in Los Angeles. I mean, I felt like the wage settlement was more than fair for both sides. based on where we're at today. The largest union that we're signatory to, we actually settled a five-year agreement with that union that during the middle of the pandemic, they basically pegged it to really consumer price increases and everything else. So it's a fair settlement. So it's things... move up and down, their wage rates are moving up and down commensurately. I don't think that we could have come up with a better solution there. So I think that we really haven't seen any issues associated with that, Catherine. And again, I feel that that's an advantage for us.

So, hey, Catherine, it's Jim. Unrelated to API, but in my early part of my career, I was a labor contract negotiator. Careful what you ask for. People don't like to open contracts because it goes both ways. If you open it for one side, then you've started the ugly precedent of two years from now, the other side wants to open it for something else, and nobody likes doing that. It's a pretty rare event when those things happen.

Catherine, just one additional point regarding steel pipe prices. Kevin whispered in my ear that they've actually come down just a little bit over the course of the last couple of weeks. So hopefully we're, you know, at the plateau and we'll see, you know, a downward trend from a steel pipe price increases.

Okay, great. And just a final cleanup question, you know, Great job on backlogs, and you have given some high-level views in terms of what is driving those demands. But if you could give maybe a little bit more granularity in terms of geographic differences. We have some. Some of the industries make sense, but are you seeing any differences in geographies and essentially anything to support that population shift to the southeast and the southwest of the U.S.? ?

Well, I would say, Catherine, that in general, we've seen really good opportunities across really most aspects of the business. Surprisingly enough, the market that's probably the most suppressed for us right now is Chicago. And I suspect that that market will slowly show some additional recovery. Obviously, the Southeast and the Southwest, with the demographic shifts, continue to provide great opportunity. But we don't really do residential work, and we don't play in markets such as that. But, you know, like as an example, one of our largest customers is Intel. They have a major expansion. It just happens to be going on in the Phoenix marketplace, which is a great market for us. And, you know, we'll continue to take advantage of those opportunities. But in general, I feel like our business is seeing really – positive opportunities across all aspects of it, you know, across really North America. And if I had to pick a market that was the softest, I would pick Chicago.

Okay, great. Thanks for answering my questions today. Have a great day.

Thanks, Catherine. We'll take our next question from Adam Dahlheimer of Thompson Davis.

Hey, good morning, guys. Roscoe, I was hoping you could give a little more color on the bidding environment, because the leading indicators for non-res construction dipped a bit during Delta, but I would say they've really re-accelerated in the past month or two. Just curious if you're seeing that in your bidding.

Well, I'm going to start, Adam, and don't take offense to this, but we do not use the word bid at API. And when we bid work, that implies that our customers are only going to select us because we have the cheapest price, and we want to provide the best value to our customers. So no offense, but I do not like the word bid. I would tell you that proposal activity for us has remained strong. The area that's probably starting to see the greatest level of bounce back is in our industrial services segment. Now, everybody has to remember that industrial services is less than 10% of our total revenue, so it's not... anything to write home about, but we are seeing some nice bounce back. But the rest of our businesses have really continued to see robust activity. Now we have seen some things specifically in specialty services that have slid out to the right. So that's one of the reasons that our backlog remains really strong is we've been able to generate revenue in each segment of our business, but we've also been able to build backlog as we move forward as some of those opportunities have slid out into the fourth quarter and actually into 2022. But proposal activity has remained strong.

What are some of the real pockets of strength within specialty?

Well, I mean, I think that we're seeing pockets of strength in that 5G, telecom, you know, fiber space, but we're also seeing that's also an area where we're seeing things slide just because of supply chain issues associated that our customers have. You know, our customers provide, you know, most of that product or a lot of that product, and availability has been, you know, a little bit of a challenge. We've seen good opportunities in our manufacturing business, and a lot of that is associated with Amazon and the distribution center marketplace. We have a number of our industrial customers have really robust work plans. that we've been able to take advantage of. Florida Power and Light, as an example, really recently came back to us because this is something that came as a result of the winter storm in Texas last year and the impact that it had on the utility space has come back and asked us to you know, retrofit a number of their electric heat tracing, you know, in a number of their different facilities. So there's really just good opportunities across, you know, most aspects of our business.

Sounds good. Nice quarter. Thanks.

Thanks, Adam. And this does conclude our question and answer session for today. I'd be happy to return the call to Russ Becker for any final remarks.

Yeah, thank you very much. I appreciate that. Number one, I want to express my gratitude again to the men and the women at API who continue to work hard and to deliver exceptional results for all of our shareholders. I'm grateful for your hard work and for your effort. And I want to thank everybody for your continued interest in API. We have just begun our journey. It's going to be an exciting ride, and we're fortunate to have each of you riding alongside us. So thank you, and have a great day.

This does conclude today's conference call. You may now disconnect your lines, and everyone, have a great day.