APi Group Corp (APG) 2020 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to APi Group's Second Quarter 2020 Financial Results Conference Call. (Operator Instructions) 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 second quarter 2020 earnings conference call. Joining me on the call today are: Sir Martin Franklin and Jim Lillie, 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, August 12, and we have no obligation to update any forward-looking statement we may make.

As a reminder, we have posted a presentation detailing our second 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. Since we completed the acquisition of APi on October 1, 2019, much has transpired in the world. However, I'm happy to say that our original investment thesis remains intact. We believe that as a result of the evolution of the company towards building a recurring services-focused business model, following the recession that began in 2008, the company has built a more protective moat around itself. This focus on recurring revenue makes us more economically resilient when headwinds such as the COVID-19 pandemic hit the economy. I'm grateful for the leadership and sacrifices across our organization during these unprecedented times. As we look to the future, we believe that APi is very well positioned for success. While we don't know what the future impact of COVID-19 may be, we remain focused on our pre-COVID-19 objectives and the long-term opportunities in front of us.

With that, I will hand the call over to Russ. Russ?

Thank you, Martin, and good morning, everyone. Thank you for your continued interest in APi. I hope you and your families are staying healthy and safe. The safety, health and well-being of all of our employees and constituencies is our #1 priority. I am proud of how our team has rallied together to combat the COVID-19 challenges and continue to serve our customers despite the headwinds they were facing. The resiliency, sacrifices and commitment shown by our approximately 15,000 team members has been inspiring. I thank them for their focus and ongoing leadership efforts during these unprecedented times.

I will start by providing a summary of our second quarter financial results and business update before turning it over to Tom, who will walk you through the results in more detail.

As many of you know, in March, following the onset of the pandemic, we initiated a cost-reduction plan to counteract the potential negative impact on top line results. While the pandemic did have a negative impact on net revenues across our 3 segments as expected, our proactive approach to managing risk across our platform and the strength of our recurring revenue services-focused business model yielded results. For the second quarter and the first half of 2020, we exceeded Street consensus estimates for revenue, adjusted EBITDA and earnings per share.

Key highlights from our performance for the 3 months ended June 30, 2020, compared to the prior year include the following: Primarily due to the impact of COVID-19, adjusted net revenues declined by 14.2% or $141 million to $849 million compared to $990 million in the prior year period, continuing success in our ongoing evolution towards achieving a profile that is more acyclical nature, with a focus on growing recurring service revenue. 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. As expected, we continue to see that our service revenue held up well.

Adjusted gross margin of 24%, which is an increase of 383 basis points, with all 3 of our segments successfully driving margin improvements. The increase was primarily driven by our Industrial Services segment as a result of our strategic focus on improving margins as opposed to growing the top line, combined with improved project management and favorable weather conditions.

In our Safety and Specialty Services segments, margin expansion was driven by a mix of work, increased labor productivity and improved pricing. Adjusted EBITDA margin expansion of 190 basis points, aided primarily by gross margin expansion and early execution of largely temporary cost containment efforts to counteract the negative impacts of COVID-19. Adjusted diluted earnings per share of $0.32, exceeding street consensus estimate by 143% or $0.19 per share.

In a challenging environment where volatility is the new normal, I'm very pleased with our results. Our ability to execute amidst ongoing COVID-19-related disruptions is a testament to the strength and resiliency of our employees, the benefits of a geographically diverse business model within the U.S. and Canada; our emphasis on growing recurring revenue with well-capitalized customers across a variety of end markets; and the relative variability of our cost structure to allow us to quickly flex with the changing market. We believe that our relentless focus on service and inspection helps build a more protective moat around the business.

As evidenced by our recent surge in cases, the pandemic is far from over. However, we remain confident in our ability to continue to execute on our long-term goals for the business. We remain focused on achieving our adjusted EBITDA margin goal of 12%. Key drivers of margin expansion include: Number one, growing recurring services revenue. This is the best way for us to continue to strengthen the resiliency of APi's business and the key to our long-term success. APi's operations are focused on end markets and services that often have a statutory requirement that tend to be economic cycle-agnostic. Good examples of this dynamic are the inspection and service work we perform in our Safety Services segment. These inspections are required by law in already-built facilities and are required regardless of whether the facility is filled to capacity or empty. Our go-to-market strategy of selling inspection work first differentiates us from our peers, and ultimately creates a stickier client relationship that leads to higher margins and growth opportunities.

Another good example is our work performed under master service agreements with private and public utility customers with large committed capital programs in our Specialty Services segment. Our long-term goal is for 50% plus of our net revenues across all of our segments to come from recurring service revenue.

Second, organic growth through attracting new customers, increasing work from repeat customers, increased demand for services, and pricing opportunities. We are actively proposing on opportunities across all of our segments. While the pandemic has presented a variety of challenges, it has also presented an increase in opportunities in certain areas, such as working with national telecom providers on the race to 5G. We believe that our customers may be seeking to extend their relationship with partners like us, as we are well capitalized and have a strong balance sheet.

Third, improved project and customer selection. We continue to focus on thoughtful and profitable growth rather than growing for the sake of growth and risking profitability. As I have stated on prior earnings calls, we are focused on reducing our contract loss rate, which refers to projects where we have a negative margin. In partnership with leaders across our individual businesses, we have evolved more robust formal go/no-go processes related to project selection, which we believe this will help us achieve our goals in this area.

Fourth, divestiture of 2 industrial services businesses that we classified as held-for-sale at the end of 2019. As I mentioned on our last earnings call, we completed the divestiture of one of these businesses in the first quarter. During July, we completed the sale of the second of the 2 businesses. These projects are now behind us, and the benefit is reflected in our adjusted financials for the Industrial Services segment as well as in our consolidated results.

Fifth, and lastly, investment in back-office infrastructure that we anticipate will help us leverage our scale. We continue to move forward with our business process transformation efforts to move towards more of a shared services model. This major multiyear effort is designed to complete the foundation for APi's transformation from a world-class private company to a world-class public company.

In addition to the organic growth drivers that I mentioned, we view M&A as an important complementary tool to increase and accelerate shareholder value over time. We intend to continue to pursue small add-on acquisitions, which APi has had success with historically, while also working with Martin and Jim to opportunistically pursue larger acquisitions in our core segments and evaluate strategic adjacencies that we may enter through M&A. We are actively engaged in conversations on both fronts.

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 some color on expectations for the remainder of 2020.

As Russ mentioned, adjusted net revenues for the 3 months ended June 30, 2020, declined $141 million or 14.2% to $849 million compared to $990 million in the prior year period. The decline was primarily attributable to negative impacts of COVID-19, combined with improved project and customer selection, which led to a decrease in the volume of projects.

For the 6 months ended June 30, 2020, total project net revenues declined by $162 million or 8.8% to $1.7 billion compared to $1.8 billion in the prior year period, due to drivers I mentioned for the second quarter.

Adjusted gross margin for the 3 months ended June 30, 2020, was 24%, representing a 383 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 our Industrial Services segment, combined with improved project management and favorable weather conditions.

In our Safety and Specialty Services segments, margin expansion was driven by mix of work, increased by labor productivity and improved pricing. For the 6 months ended June 30, 2020, adjusted gross margin was 23%, representing a 351 basis point increase compared to prior year, due to the drivers I mentioned for the second quarter.

Adjusted EBITDA margin for the 3 months ended June 30, 2020, was 11.9%, representing a 190 basis point increase compared to prior year, aided primarily by gross margin expansion and early execution of our largely temporary SG&A cost containment efforts, counteracting the negative impacts of COVID-19.

For the 6 months ended June 30, 2020, adjusted EBITDA margin was 9.8%, representing 114 basis point increase compared to prior year, due to drivers I mentioned for the second quarter. While we are pleased with the 190 basis point improvement in adjusted EBITDA margin for the quarter, our SG&A operating expenses reflect the impact of certain temporary COVID-19 cost savings measures. We expect a level of these expenses to return in the second half of the year.

Our strong cash generation has continued, and our balance sheet and liquidity profile remain strong. For the 6 months ended June 30, 2020, adjusted free cash flow was $223 million, representing a $201 million increase compared to prior year of $22 million. Our adjusted free cash flow conversion rate was approximately 137%, exceeding our goal of 80%. The increase in cash flow was primarily driven by the change 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.

As of June 30, 2020, we had $607 million of total liquidity, comprising $377 million in cash and cash equivalents and $230 million of available borrowings under our revolving credit facility. As of June 30, 2020, we had $1.2 billion of indebtedness outstanding under the 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 2.2:1 as of June 30, 2020.

I will now discuss the results in more detail of each of our 3 segments, beginning with Safety Services. Safety Services net revenues for the 3 months ended June 30, 2020, declined 16.4% or $73 million to $371 million compared to $444 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 6 months ended June 30, 2020, net revenues declined by $75 million or 8.6% to $795 million compared to $870 million for the prior year period, due to the factors I mentioned previously, along with the timing of contract revenue.

Service represented approximately 40% of the segment's net revenues for the 3 months ended June 30, 2020, up from approximately 36% in the prior year period. Service revenue outperformed relative to contract revenue as expected, declining by 5.2% or $8 million to $149 million compared to $158 million in the prior year period due to COVID-related matters. For the 6 months ended June 30, 2020, service represented approximately 39% of segment net revenue, up from 35% in the prior year period. The Service revenue increased by 1.5% or $5 million to $308 million compared to $303 million in the prior year period.

Adjusted gross margins for the 3 months ended June 30, 2020, was 31.8%, representing a 253 basis point increase compared to prior year, due to the impact -- due to improved mix of service, work and the increased efficiencies. For the 6 months ended June 30, 2020, adjusted gross margin was 30.9%, representing a 152 basis point increase compared to prior year, primarily driven by continued shift in mix of work towards inspection and service revenue. On average, we estimate that gross margins on inspection and service revenues are approximately 10% higher than gross margins on contract revenue.

Adjusted EBITDA margins for the 3 months ended June 30, 2020, was 12.7%, representing a 17 basis point decline compared to prior year, as expected. Selling, general and administrative expenses in this segment did not decline as fast as net revenues, as we continued to invest in growing our inspection and service business model. For the 6 months ended June 30, 2020, adjusted EBITDA margin was 12.6%, representing a 41 basis point decline compared to prior year.

Specialty Services net revenue for the 3 months ended June 30, 2020, declined 15.7% or $65 million to $349 million compared to $414 million in the prior year period. 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 timing of projects. For the 6 months ended June 30, 2020, net revenues declined $51 million or 7.3% to $649 million compared to $700 million in the prior year period, due largely to the factors I mentioned for the second quarter.

Adjusted gross margin for the 3 months ended June 30, 2020, was 17.8%, representing a 255 basis point increase compared to prior year due to increased labor productivity and improved pricing. For the 6 months ended June 30, 2020, adjusted gross margin was 14.9%, representing 166 basis point increase compared to prior year, due largely to the factors I mentioned for the second quarter.

Adjusted EBITDA margin for the 3 months ended June 30, 2020, was 14.6%, representing a 326 basis point increase compared to prior year, primarily due to improved pricing and increased efficiencies in the execution of our services. For the 6 months ended June 30, 2020, adjusted EBITDA margin was 10.6%, representing a 163 basis point increase compared to prior year, due to the factors I mentioned for the second quarter.

Moving on to Industrial Services, excluding businesses classified as held-for-sale or divested as of June 30, 2020, Industrial Services adjusted net revenues for the 3 months ended June 30 declined 1.5% or $2 million to $133 million compared to $135 million in the prior year period. For the 6 months ended June 30, 2020, adjusted net revenues declined by $35 million or 13.1% to $232 million compared to $267 million in the prior year period. The decline was primarily due to decreased volume as a result of strategic focus on improving margins as opposed to growing top line.

Adjusted gross margin for the 3 months ended June 30, 2020, was 18%, representing a 1,286 basis point increase compared to prior year, primarily driven by productivity increases due to improved project and customer selection, project management and favorable job site conditions. For the 6 months ended June 30, 2020, adjusted gross margin was 17.7%, representing a 1,468 basis point increase compared to prior year, due to the factors I mentioned for the second quarter.

Adjusted EBITDA margin for the 3 months ended June 30, 2020, was 15%, representing an 837 basis point increase compared to prior year, primarily as a result of our strategic focus on improved margins as opposed to growing the top line. For the 6 months ended June 30, 2020, adjusted EBITDA margin was 13.4%, representing a 1,037 basis point increase compared to prior year, due largely to the gross margin improvements mentioned earlier.

Before turning the call over to Jim, I would like to provide some color on expectations for the remainder of 2020. We had approximately $19 million of COVID-19-related SG&A cost savings during the quarter, a majority of which were due to temporary actions such as salary, 401(k) and compensation-related benefits that we began to unwind in June. As a result, you will likely see incremental expenses in the business results in the back half of the year.

Regarding full year guidance, current Street consensus estimates for 2020 are revenue of approximately $3.5 billion, adjusted EBITDA of $337 million and adjusted earnings per share of $0.84. As we move through the balance of the year and gauge the ongoing impact of COVID-19, we will modify our outlook on a regular basis. However, based on our progress to date in 2020, we believe that adjusted net revenues for the year will range between $3.4 billion to $3.5 billion, adjusted EBITDA will range between $345 million to $355 million, and adjusted earnings per share will range from $0.94 to $1 per share based on adjusted fully diluted share count of $174 million, excluding any impacts of warrants. We expect capital expenditures for the year to be approximately $35 million and depreciation to be approximately $80 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, everyone. We believe that APi's early expense reduction actions, strong cash flow generation, conservative balance sheet and liquidity profile provide us with a stable foundation to continue to navigate the uncertain economic climate while also providing us the flexibility to capitalize on the recovery and invest in strategic opportunities.

Although market conditions as a result of COVID-19 remain uncertain and visibility is still somewhat limited, we believe that we are well positioned to continue to execute on our long-term goals. The business has shown its resiliency, and the leadership has shown its hands-on approach to proactively and preemptively addressing challenges. It's a cultural approach to running the business that we are used to and proud of. We believe that for those of you getting to know the company, that it has to date shown the strength of the proactive and protective moat and that the business has shown its resiliency in a very challenging environment. While we had not expected to be stress tested this quickly as a public company, we believe that our results support the investment thesis we had when we first met Russ and the team.

As you know, we are focused on making the right choices for the long-term health of the business, being opportunistic on M&A, and remaining focused on creating sustainable shareholder value by focusing on our long-term value creation targets, which are: one, delivering long-term organic revenue growth above the industry average; two, continuing to leverage our SG&A; three, expanding adjusted EBITDA margins to 12% plus by fiscal year 2023; four, adjusted free cash flow conversion of 80% plus; five, generating high single-digit average earnings growth; and finally, number six, targeting long-term net debt-to-EBITDA ratio of 2x to 2.5x.

With that update, we'll turn the call back over to the operator and open the call for Q&A.

(Operator Instructions) Our first question comes from the line of Andrew Wittmann of Baird.

Just to understand the business trends that happened during the quarter a little bit better, either Russ or Tom, I was hoping that you could talk about what you saw as the quarter progressed. Obviously, you gave us the update kind of halfway/a little bit more through the quarter here. But just kind of want to see the month-over-month cadence on organic revenue trends and then certainly an update about what you've seen in July. You mentioned some deferrals in the quarter. Are those deferrals coming into action? Or are they still deferred? I think some commentary around that, even by segment, would be particularly helpful for everyone to understand what's happening with the business today.

Yes. So thank you for your question. We have seen things -- we track man-hours by business, and we've seen man-hours slowly continue to tick in an upward fashion really across most all of our businesses. If you look specifically at Safety Services, one of the things that we watch very closely, because we are so focused on the inspection and service component of the business, as we watch our inspection man-hours, and our inspection man-hours are actually up year-to-date about 7% or 8%, which is a positive sign for us. And so as building -- as the shelter-in-place orders start to relax and business continues to open up, we expect that the service component of our work will closely follow. So that's a good positive key indicator for us as it relates to the work in our Safety Services.

Specialty Services, the acyclical nature of that business continues to show itself. We see -- if we look at our contract backlog and the other work associated that we have in front of us, we continue to see positive results there as well, and we remained very optimistic about the opportunities that are going to come. You still see -- like we're still seeing some opportunities that we have slide to the right, but it seems to be normalizing and that's starting to flatten out. But I think that we're going to continue to see some of that volatility probably throughout the course of the next year, which I think most folks would concur with.

So -- and then Industrial Services, which is our smallest piece of our business, we continue to focus our emphasis on the services side of the work that we're executing with that group. And that's just a continued effort that's going to push us forward and something that we're going to need to continue to drive as the year progresses and moves on.

Great, that's helpful. Maybe just another way to add a little bit more color on that as my follow-up question. I wanted to touch on backlog. I think you mentioned that in your answer there on one of the segments. But in terms of bidding pace and ability to put awards into the backlog, has that slowed down as well? Are you still able to put things into backlog and not execute it? Could you talk maybe -- the best way to answer this would be to talk about kind of how the sequential performance in your backlog has held up during the quarter from last quarter to this quarter. Is it up, down? That would be helpful.

Yes. So number one is that we do not use the word bid at APi. And we propose on opportunities because we do not want to be selected by any of our customers based on our price. And so I don't say that with sarcasm, I say that with sincerity. I mean I have literally told our people that we do not bid work. And there's a difference in mindsets when you think about that.

So to really answer your question, the -- our contract -- our backlog under contract is slightly ahead of where we were at this time last year, which is positive for us. And so we continue to see robust opportunities in our pipeline, in our funnel. In some aspects, we've seen a slowing of, maybe I'd call it decision-making, from when that proposal gets to our client and that client makes a decision to move forward. But in general, our backlog has been very, very solid and been holding up very, very well, which is positive. And for us, I had alluded to in my remarks, that we've implemented a more robust go/no-go process selection for the opportunities that we're going to pursue.

And so with saying all that, I can comfortably tell you that the quality of our backlog has improved as well as just holding up. So we're positive about that.

Great. I just want to ask one kind of technical question here for Tom before I jump off, and that was regarding the free cash flow. It was obviously very good in the quarter. And you mentioned kind of the working capital as a result of the revenues being down. That makes sense. But just curious as to how much free cash flow you were able to generate this quarter as a result of the federal payroll tax deferral and what your expectations are for the year on that amount? Just so that we can model that appropriately as it get paid back next year and the year after.

Yes. So roughly about $12 million in the quarter, and you can ballpark that each quarter.

Our next question comes from the line of Markus Mittermaier of UBS.

Maybe briefly if I start off with the guidance. Thanks, first of all, for giving that. Not many companies have done that. So if I look at sort of the cadence, first half, second half, I wonder, what's your assumption sort of like on top line. Because you did just under 1.7, so the implied second half top line number is roughly the same. So is that selectivity around industrial, is that sort of conservatism? You mentioned sort of the backlog is looking okay. I'm just trying to get a bit of a sense for the assumptions you took to come up with that second half implied guide. Let's start there.

Yes. So in building that guidance, we go out to our businesses, and we build it up from the ground up. And based on what they were seeing at the time of putting that together, and with still some of the headwinds of COVID and some of the spikes that are coming back up, we look at that and believe that that's a very appropriate place for us to be at this time, given the general macro economy.

Okay. Got it. But ex-COVID, it would be fair to assume that sort of from a underlying seasonality, usually the second half is better than the first half. Would that be fair?

Yes. That would be fair.

Okay. Great. And then...

Markus, it's Jim. Basically, the front half in any given year is about 40%, and the back half is about 60%, give or take.

Yes. Got it. Okay. Great. And then maybe on cash flow, just -- I get the point around sort of like the tax deferral and the impact on that. But even if I exclude that, obviously conversion is very strong, was also sort of like ahead of the 80% in the first quarter. How should we think about both this and also your longer-term margin guide? Because already now you're kind of in the quarter, very close to your sort of medium and long-term margin target. I understand that there's some cost coming back. But if we assume regular incrementals in the second half and business stabilizing, how should we really think about that sort of like cash conversion longer term? Is the 80% still a reasonable number? And also on the margin side, maybe think about whether there is a chance that we can get to that 12% target earlier than what you have previously communicated.

I'll let Russ and Tom answer that, but I appreciate you trying to change our long-range guidance, Markus. We want to make sure that we deliver on the goals that I laid out in our comments, including getting to 12% plus by 2023. Nobody would have expected a pandemic when we initially gave out that guidance. And so, obviously we'd rather be in a position of underpromising and overdelivering, but we're not going to change the long-range guidance that we've given.

And with that, I'll let Russ and Tom respond to the micro part of the question.

Yes. So Markus, on the EBITDA margin, we made progress in the quarter. We're happy with what we did in the quarter, but there were things that were temporary in there. And when we back those things out, we're back into that 10% range versus the 11.9%. So I think it's fair for you to think about it that way, and we'll continue to make the progress as planned to 2023.

With regards to cash conversion, because we think that that revenue decline has happened, we wouldn't expect us to be in that 137% conversion in the second half. But we're comfortable with the 80% on a consistent and mid- and long-term basis.

Our next question comes from the line of Andy Kaplowitz of Citigroup.

Russ, I wanted to follow up on the comments around inspection man-hours up 7% to 8% as of now. It's good to see the annual guidance out there. Can you talk about what you're assuming in the guidance for service and inspection in the second half of the year? And because we don't have the second half of '19 actuals, can you tell us approximately what you're assuming for organic revenue decline in the second half of the year versus the 14% decline you saw in Q2?

Yes. So like inspection man-hours is going to ultimately drive our service revenue. And I think we provided data in the past, specifically in our life safety businesses, that approximately 45% of the revenue comes from inspection and service. So as we -- we would be hopeful that we can get the service component of the inspection and service piece of our business rocking and rolling in the second half. We haven't provided any guidance about where we specifically see that revenue coming from. But we're optimistic, because we've seen growth in the inspection component of the business, that we will continue to see upward projections from a revenue perspective as associated with our service work.

All right. So I just want to follow up also on the comment that you made around the sort of 10% underlying margin. Obviously, we know that you've had sort of temporary costs out, and you have to give some or maybe all of that back. But maybe you can talk about -- in a more normalized environment, you did very strong margins in Specialty Services. Margin Safety were good. Industrial margins have been coming up over the last couple of quarters. Can you sustain these double-digit margins in Specialty Service and Industrial moving forward? And then how do we think about these temporary costs out in the sense that can any of these costs out be structural as you go forward?

Well, I mean we shared that we've saved about $19 million in SG&A expenses associated with kind of our cost containment efforts and -- which are positive. And part of that is some pruning that was done inside these businesses. And we haven't necessarily done the exact math to say how much of the pruning was the $19 million versus salary reductions and furloughs and some of the expenses that we expect to return. So we're going to see a little bit of margin pressure as we move forward into the second half.

Traditionally, in the space, you see -- whenever there's a potential economic downturn, you see pricing pressure that works its way into the market. We have -- so our discipline from our project selection and customer selection, that go/no-go process that we've implemented, it's going to be very, very important for us to be -- to maintain the margins that we've been able to execute on. So a big part of that comes from this whole concept of being disciplined around who we work for and what projects that we pursue from -- as a company and -- but it's all possible and it's all doable.

Great. And then just one more follow-up from me for Russ, maybe Jim and Martin. As you give these temporary costs back and you think about M&A, then -- I mean is it sort of a balance here, where in the second half of the year, you've talked about sort of dusting off some of the M&A plans, but you have to sort of be careful with the environment? Obviously, valuations are all over the place. So what do you see out there in terms of M&A and the focus that you have on it? Do we wait until all these costs come back? Or can you start to get going here on that?

So I would say that we have -- I put it into 2 buckets. We have the ongoing M&A program that Russ and the APi team have executed on in the smaller, if you like, bolt-on opportunities. Those are continuing. There's a pipeline. There was a slowdown really because of COVID that is now, if you like, back in gear. We had a session on that in the last couple of days. And then on sort of, if you like, more additive M&A for slightly larger businesses, that pipe is also back up and running. So we are active in that process for opportunities for us.

So from my perspective, there are opportunities out there. I don't think pricing for what we're doing has gotten, if you like, out of control and it is consistent with what we see. We spent a lot of time with the leadership organization on this and we've been together in Minnesota for the last few days going through that. So there'll be some opportunities. The good news is the business is well positioned for it. The cash production in the business and the conservative balance sheet, we have plenty of capacity to take advantage of opportunities that are in front of us.

Our next question comes from the line of Kathryn Thompson of Thompson Research.

I wanted to follow up, just to dig a little bit deeper on those margin and just kind of the outlook. But when you look at segments, and really primarily Safety and Specialty, really want to parse out what is more transitory. So what will likely come back with increasing volume and work versus more fundamental changes? You know you addressed a portion of this earlier in the call, but really would like to get a better sense of some of the more fundamental changes that could have sustainable margin improvement.

Well, Kathryn, thank you for participating. And I mean I don't want to oversimplify by any stretch of the imagination, all right? So as we march towards our long-term EBITDA goal of 12% by 2023, the areas that are going to have the greatest level of impact are: number one, disciplined project customer selection and reducing our loss rate. So if you recall, we had a published loss rate last year of 1.5%. We said that our goal this year was to cut that in half. We've made progress on that. We need to continue to make progress on that, but that's a huge portion of the sustainability of the margins. That's -- in my opinion, that's the lowest-hanging fruit that we potentially could have.

We need to continue to drive the mix of our business. And as we -- if we can continue to sustain 7% or 8% growth in our inspection business, we're going to drive -- continue to drive the growth of our service business, which drives that recurring revenue mix goal to closer to 50%. If you recall, the gross margins for that work are typically 10 points better, and that's going to be a big, big driver for us.

And then I would say increased execution inside our businesses. And we still have businesses that we know can be better and they must be better. And so we need to evaluate each of those businesses and be making the choices and the decisions that we can to improve those businesses. And that doesn't even talk about our business process transformation project, which we are hoping that that long-term effort is going to allow us to really truly move to a shared services model, and help us to reduce our SG&A on a longer-term perspective. And then you couple that in with strategic M&A.

So it really is -- it is really, truly hitting a bunch of singles versus stepping up to the plate and knocking it out of the park with one fell swoop. So it's -- and that's where our focus and that's where our priority is. And that's why I think Jim made the comments earlier about we're not changing our guidance as it relates to our long-term objectives because as we return some of these costs, we're going to have to continue to drive all of these other points if we're going to be successful in achieving that goal.

Two follow-ups to that. If your loss rate was 1.5% last year, where is it today? And then the second, is it fair to say that the margin upside in the quarter was more driven by fundamental changes and not just transitory events?

Well, I think number one...

So in other words, cutting on your head-?

Well, number one, I don't have what our loss rate is sitting at the tip of my tongue right now. I directionally know that it's improved. And that's just because most of those -- most of the time, if there's a problem, that rises to my attention and rises to my desk. And so from that perspective, I'm speaking more directionally and intuitively. And we need to evaluate that on a year-over-year basis regardless, but we are making progress as it relates to that goal.

And I don't necessarily know when you talk about transitory...

So headcount cuts. There's a whole host of companies, services companies that have reported where you're able to cut costs just by cutting headcount and that those costs will come back as volumes improve. So it's really separating that out from some of the fundamentals that you focused on as a company. Does that make sense?

So -- yes. So I mean that's the beauty of our business, right, is the ability for us to flex our workforce up and down, based on our customers' needs and the demands that we see in the marketplace. And I said this earlier, we took the opportunity to do some pruning. And any business that's been on really a positive 8- to 10-year run ends up with, I'll just say, less-than-average performers in their business. And so we wanted to make sure that we took advantage of the pandemic and made sure that we did pruning where that was appropriate.

But we also -- we're really focused on trying to preserve our workforce so that as the market returned to a more normal time, that we were able to be in a position where we could start rocking and rolling again. And so we actually used salary reductions and furloughs and job sharings and things like that so that we would be able to maintain that workforce as best we could as the market returned. We're -- I think that's evidenced by the fact that we're seeing our man-hours, on a business by business case, start to tick up.

Our field workforce is primarily a union field force. We do have some nonunion businesses as well, but we're primarily a union workforce. And that provides us with additional flexibility to flex. And because there are no trailing severance costs and such for the individuals that are members of a union, so as we -- our work needs flex up and down, it gives us a much more flexible model to work within. So I hope that answers your question.

Kathryn, maybe I can just jump in also. And we talked about it throughout the script. But the ongoing consolidation of back offices continues to evolve, so that's a contributor. The mix of the business is also a contributor. You've got some things going against you. For example, we used to put 2 guys in a service van. But because of COVID, our expenses have gone up a bit because now 2 guys take 2 vans for COVID reasons.

And so there's business process improvement. There's mix improvement. There's continuing to leverage scale, and there are some headwinds. And then, obviously the temporary salary reductions, including Russ still not taking a salary, will need to come back in. The 401(k) will need to come back in. But ultimately, we're comfortable with the levers that Russ and the team are pulling to drive the business forward and get us to those margin goals in 2023.

That's a helpful rounding out. Thanks very much for both of you on that. Stepping back and looking at a bigger picture question and looking at the opportunities in a post-COVID world, what services or segments you could see gains? And what areas could be more at risk?

Well, we see the opportunity for gains, I guess, essentially across the deck. Obviously, the opportunity to continue to grow inspection services and safety is -- like that's the #1 priority for the company. And we see opportunities to grow the business, primarily when you think about Specialty Services and the race for 5G in the telecom industry. And there's tremendous opportunities in that space as well. And we're just trying to be disciplined in our approach as we look at some of these additional places where we can grow the business.

And then in Industrial, there's an aspect where we've been very purposeful about going backwards before we go forward and being focused on margins, and you've seen that in our results. And part of that is also making sure that we're focused on the service side of that business. And so you'll see us continue to be very, very disciplined and focused less on revenue in industrial and more focused on margins. So the primary places that we're focused on growing are going to be in Safety Services first and Specialty Services second.

Okay. Are there any type of Specialty Services that you offer that specifically address some of the inevitable changes as we all adjust to a new world with COVID? So could you see increased inspections because of that? Because we've seen that with other businesses, too. Just really trying to understand what those opportunities may be.

Well, I mean in Specialty Services, if you're talking specifically, there -- well, I'd say there's 3 probably areas that just come to the front of my mind. One of them I talked about, which is this race to 5G in telecom. Obviously, when you have situations like what happened in Baltimore the other day, where you had the residential neighborhood that had the explosion due to the existing natural gas distribution system in the -- and they referenced right in a number of the articles that I read about it, the fact that the system is leaking as much as it is, that creates a lot of opportunity for us, unfortunately. And that's an area of expertise. It's highly complicated work to do. And you need to have sophisticated protocols to be able to successfully do that work. And so there's opportunities for us in that space as well.

And COVID is driving some HVAC upgrades. We don't -- it's not a huge part of our business, but we've seen some rise in opportunities with our clients to upgrade and improve the quality of their air systems in their buildings, primarily in secondary education type institutions.

And ladies and gentlemen, we have time for one more question. Our final question will come from the line of Jon Tanwanteng of CJS Securities.

Congratulations on a nice quarter. My first one, maybe, Russ, I think you might have addressed this, but I just want to get a little more solid answer. How are trends in July versus June and maybe into August across the business lines? And secondly, from a Q3 versus Q4 perspective, which do you expect to be relatively stronger, given the current activity and your assumptions around COVID activity -- COVID resurgence and your normal seasonality?

Jon, directionally, we expect July to hold up. And we haven't seen anything that would send us any other sort of a mixed message. And I guess the single biggest indicator for us is watching our man-hours. And we watch man-hours, again, by business and watching where the trends for those man-hours go, and there's nothing there that necessarily -- that sends us any sort of alarm. Our third quarter will be stronger than our fourth quarter.

Got it. That's helpful. And then I just wanted to follow up on the man-hours comment. You said that inspection hours were up year-over-year. I get the implication that maybe the service that follows that, where you generate, I think it's like $4 to $5 on every inspection dollar, it didn't quite catch up with that level. I'm wondering is that the case, number one. And number two, is there a period of time where you've done an inspection and maybe those results go stale, and you have to do another inspection before you can actually generate the service tail end of that? Some color on that would be helpful.

Well, I mean it's possible that you could do an inspection and you could make a proposal to a client with the deficiencies, and they would choose not to do it for whatever reason. That doesn't happen very often with our book of business because the end markets that we're serving, in my opinion, are in a much better position.

I've said this before, we do not do a lot of business in the hospitality and the retail space, which have been harder hit end markets. So I think that the reason that you see a little bit of a bump from us or when I say bump, a drag is really a better way to put it from a service perspective, it's just because of all the different shelter-in-place orders and the difficulty it is in getting access to some buildings. And the environment is still not easy to work in. And you're seeing the surge in the cases. And so trying to be efficient as we do that work is the other part of the challenge. And so we suspect that because we feel good about our customer base that that work is all going to get done. It's just a matter of when.

The other part of it is that we typically see $3 to $4 worth of service work driven off of every dollar of inspection work, not $4 to $5. And so just to, I guess, provide better clarity and direction there for everybody that -- else who's on the call.

Got it. I appreciate that correction. Lastly for me, just any comment on the competitive environment. I know you've remained disciplined, but I know newbuild activity is probably coming down. Are your peers and competitors in the field seeing your business model as more attractive, maybe competing more on the inspection side at this point in time? Or are there any other trends or puts and takes that we should be thinking about from a competitive aspect?

Yes. So you always see -- in times like this, you see people wake up one morning and think to themselves, "Jeez, we should be doing more inspection and service work, and we should really get focused on that," and then they try to move into the space. The challenge for them is that they don't have the infrastructure development that we have. And so this selling inspections-first model for us, the -- I guess the intangible aspect of that is the ability to build better and stickier client relationships.

So we have developed and grown an inspection sales force that sits inside all of our branch offices across our business. In those individuals, they measure customer touches and how often they're engaged with their customers and things like that. And so for somebody to just walk in off the street and say, "Hey, I want to do your inspections," it's just not going to happen. And it's not -- when you're dealing with reputable clients with the right end markets, it's about the best value. And it's not about whether somebody can save them $220 on their inspection. And if you look at that segment of our business, the average project size is under $10,000. And that's because we're doing a gazillion inspections at $1,000 a pop.

And so even if somebody goes in and says, "I can do it for $950," people don't care about the $50. They care about the quality of the work and making sure that it's done properly and everything else. And so when you have that infrastructure already built and in place and functioning, it's very, very difficult for somebody to just walk in and take that work away from you. So we feel good about the resiliency, and we actually have aggressive growth goals and are going to continue moving that forward.

And ladies and gentlemen, that was our final question. I'd like to turn the floor back over to Russ Becker for any additional or closing remarks.

Well, I would just like to take the opportunity to thank everybody for joining the call this morning and for having continued interest in API. We remain very proud of the leadership that each of our businesses has shown and the personal sacrifices that each and every one of our employees has made on behalf of the company. And they truly have put APi first and themselves second. And I think that's a testament to the results that we were able to share with you this morning.

So thank you again, and we appreciate your long-term interest in the company.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.