FirstService Corp

TSX:FSV

Earnings Call Transcript 2018-Q1

[Operator]

Welcome to the first quarter investors conference call. Today's call is being recorded.Legal counsel requires us to advise that the discussion scheduled to take place today may contain forward-looking statements that involve known and unknown risks and uncertainties. Actual results may be materially different from any future results, performance or achievements contemplated in the forward-looking statements.Additional information concerning factors that could cause the actual results to materially differ from those in the forward-looking statements is contained in the company's annual information form, as filed with the Canadian securities administrators, and in the company's annual report on Form 40-F, as filed with the U.S. Securities and Exchange Commission.As a reminder, today's call is being recorded. Today is April 25, 2018.I would like to turn the call over to Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

[D. Scott Patterson, CEO, President & Non]

Thank you, operator, and welcome, everyone, to our first quarter call. Thank you for joining.This morning, we announced very strong results for the March quarter, driven primarily by the same themes that we have seen really over the last 3 years, and that is: strong organic growth at FirstService Brands; year-over-year margin improvement at FirstService Residential; and solid tuck-under acquisition activity, which enhances our top line growth.We're very pleased with the way we started fiscal 2018 and believe the momentum bodes well for achieving our full year objectives.I will spend the next few minutes taking you through some of our highlights for the quarter. And then Jeremy Rakusin, our CFO, will follow with the financial review.Revenues for the quarter were up 12% over the prior year, with organic growth at 6%, and the balance from several tuck-under acquisitions closed over the last year. EBITDA was up significantly, 26% versus 2017, driven by continuing margin improvement at FirstService Residential, but also by margin expansion at FirstService Brands, which is more mix related. Jeremy will provide more detailed commentary on divisional margins in a few minutes.And finally, our earnings per share for the quarter increased 56% to $0.25 from $0.16.Again, this quarter, both our divisions generated strong results. At FirstService Residential, revenues grew by 7%, with the organic growth accounting for about half, which is generally consistent with the growth rates we've seen over the last year.Organic growth was balanced geographically, with every region up over the prior year, and also by service line, with ancillary service revenue up generally in lockstep with management fee revenue.Top line growth benefited from the addition of 5 tuck-unders over the last year. Notable additions were Zalco Realty, a leading high-rise management company in Washington, D.C., and Paradise & Associates, the #2 management company in Minneapolis, St. Paul, #2 behind us. Both of the acquisitions served to significantly bolster our leadership positions in these important markets.There are a few markets left for us in terms of new geography, so our tuck-unders will increasingly be in existing markets where we are focused on increasing our share, and these are 2 examples. Both deals closed in Q3 last year.Turning now to FirstService Brands, where we posted another great quarter, with total revenue up 24% over the prior year and organic growth again very strong at 10%. It is the fifth consecutive quarter with double-digit organic growth.We're clearly benefiting from a robust home improvement market, but the organic growth is also a positive reflection on the strength of our brands and our ability to take market share. We have invested in building capacity across the brands over the last couple of years and are now in a better position to convert and execute on the leads we are generating. 10% growth is close to double what we believe the overall market growth rate to be.All our major brands generated strong organic growth during the quarter and contributed to our results, with no one brand standing out in terms of organic growth.In terms of overall growth, California Closets and Paul Davis Restoration stood out due to acquisitions we made over the past year in advancement of our company-owned growth strategies.At California Closets, we added 3 major markets to our portfolio over the last year. We acquired our Orange County franchise in Q2, which is one of the largest operations in the system and a very important add strategically. Later in the year, we acquired the Atlanta franchise. And in Q1 of this year, we added our Las Vegas franchise. These 3 bring the total number of company-owned operations to 16, with annualized revenue of over $150 million.We also made significant progress in our company-owned strategy at Paul Davis Restoration, with 4 acquisitions over the last year. We added Paul Davis Omaha in the second quarter of 2017, the Washington, D.C. franchise in Q4, a non-Paul Davis Restoration business in Q1 of this year, which I will touch on in a moment, and most recently, our leading franchise in Western Canada, which did not impact the Q1 results, but is certainly noteworthy in terms of kickstarting our company-owned strategy in Canada.As a reminder, our goal is to own the major markets and create a consistent transparent North American-wide service offering, specifically targeted at national insurance companies and commercial accounts. Where there are gaps or weaknesses in the Paul Davis footprint, we will look to fill those, either by selling a Paul Davis franchise in that territory, by converting an independent restoration company into the Paul Davis brand as a franchisee, or if it is a strategically important major market, we will look to acquire a quality independent operator as part of our company-owned strategy. And we did that in Q1 with the addition of a company that added capability and filled the geographic gap for us.We now own 8 operations, with a longer-term goal of owning at least 25 to achieve the network that we believe we need to differentiate ourselves with national accounts. We established this strategy 3 years ago. It's a longer-term plan for us. And we are very pleased with our progress to date and the momentum we have.As I mentioned at the outset, we feel good about our start to the year and the prospects for the balance of the year. And on that note, I will transfer over to Jeremy for his financial review.

[Jeremy Alan Rakusin, Chief Financial Officer]

Thank you, Scott, and good morning, everyone. As summarized in this morning's press release and reaffirming Scott's comments, we reported another quarter of very strong results. I will walk through our overall consolidated and segmented financial results for the quarter, our cash flow and capital deployment, and finally wrap up with our balance sheet position.First, let me highlight our consolidated first quarter financial results.FirstService reported revenues of $426 million, up 12% over the $380 million in Q1 2017. Adjusted EBITDA was $25.4 million, representing 26% growth over the prior year's $20.1 million, with a 6% margin for the quarter, up 70 basis points year-over-year. And our adjusted EPS was $0.25, a 56% increase over the $0.16 per share reported for the same period last year.Adjustments to operating earnings and GAAP EPS in arriving at adjusted EBITDA and adjusted EPS, respectively, are outlined in our press release issued this morning and are consistent with our approach and disclosures adopted in prior periods.One other accounting-driven point I'd like to highlight before diving into our segmented performance is a new required U.S. GAAP change to revenue recognition in effect as of January 1, 2018. The effect of this accounting change is relatively insignificant to our consolidated financial results. The impact is confined to our franchised operations within our FirstService Brands division, particularly as it relates to the timing and recognition of franchise and marketing fund fees.In accordance with U.S. GAAP, we have recast our prior-year period results to allow for an apples-to-apples comparison to the current year results with the new standard in effect. The aggregate impact on the recast Q1 2017 consolidated results was a $4.4 million increase in revenues, a $600,000 decrease to the adjusted EBITDA line and $0.01 decrease to our adjusted EPS. The implied margin impacts on our consolidated and brands division results are cited in this morning's press release.Finally, I would also note that this accounting change has no impact on our cash flow.With that clarification out of the way, let's now turn the focus to our divisional highlights for the quarter.Starting with FirstService Residential.We reported revenues of $284 million, up 7% over last year's first quarter. EBITDA for the division was $17.5 million, a 21% increase year-over-year, yielding a margin of 6.2%, up 80 basis points versus last year's 5.4% margin.A part of the margin improvement continued to come from our ongoing multi-year effort around operating efficiencies and optimizing our resources. The margin expansion, however, was also amplified in the quarter by tuck-under acquisitions within the FirstService Residential division completed since mid-2017.These transactions added property management and ancillary amenity services, which have year-round operations and a nonseasonal cash flow profile. Their contribution accentuated the increased overall margin of the division during its seasonally weakest first quarter.Shifting now to our FirstService Brands division. We generated revenues of $142 million during the first quarter, up 24% over the prior year. And Scott has already walked you through the top line drivers.EBITDA for the division increased 35% to $11.2 million, up from $8.3 million in the prior-year quarter. FirstService Brands margin modestly expanded to 7.8%, up from the prior year's 7.2% level.Similar to my earlier comment around the FirstService Residential division, a portion of the margin improvement was attributable to recent acquisitions of nonseasonal company-owned operations, which averaged up the seasonally low Q1 margins of our franchised operations. Some businesses within the division also benefited from operating leverage due to this strong top line growth.The combined operating earnings across both divisions drove strong first quarter cash flow from operations of $23.4 million before working capital changes, up 50% versus last year. Operating cash flow after working capital requirements came in at $8.3 million, reflecting the elevated ramp-up of working capital during our seasonal trough quarter.In terms of our capital investment activity, during the first quarter, we incurred just over $10 million of capital expenditures in support of our businesses, relatively in line with the prior-year quarter and tracking closely on an annualized basis to the estimated total full year spending of $40 million I have noted previously.We have also been active with our tuck-under acquisition program in the early part of 2018. During the first quarter, we deployed almost $30 million towards deal activity, primarily directed in support of our Paul Davis Restoration and California Closets company-owned operations, where we added key markets to our geographic footprints.We are pleased with what we have achieved year-to-date on the acquisition front and expect continued activity for the balance of the year across our business lines.Lastly, looking at our balance sheet. We closed this first quarter with a net debt of $262 million, resulting in a 1.5x leverage ratio, measured as net debt to trailing 12-months EBITDA. These debt metrics are modestly higher than at our 2017 year-end, as is typically the case, given our working capital funding requirements during our seasonally lowest cash flow quarter and the solid level of capital investments we made during the quarter. Our liquidity in terms of our undrawn credit facility balance and cash on hand stood at more than $140 million at quarter-end. Our conservative balance sheet is a key area of strength, providing us with lots of headroom and flexibility to move on opportunities as they arise and deploy capital to advance the growth of our businesses.We have gotten out of the blocks quickly in early 2018 with the strong quarter and solid tuck-under acquisition activity. This momentum, together with the positive macro outlook and key indicators across our businesses, provides us with good confidence in our ability to hit our full year growth targets.That now concludes the prepared comments. I would please ask the operator to open the call to questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Stephen Sheldon from William Blair.

[Stephen Hardy Sheldon, Analyst]

I guess, first, your margins within the residential segment continued to trend up nicely year-over-year, and you've talked about still having room to improve margins, especially in regards to client accounting. So just curious if you saw any impact from efficiencies in client accounting in the quarter, and maybe just some more color on how the accounting platform and standardization across regions could drive margin improvement there over the next few years.

[Jeremy Alan Rakusin, Chief Financial Officer]

Yes, Stephen. Yes, a portion of the margin improvement for the quarter in residential was client accounting and other modest operating efficiencies. The rest, as I mentioned, was due to the mix and seasonality. The opportunity to ramp client accounting, we believe we've still got a couple years of that. It is going to drive margin improvements, albeit at significantly smaller increments than what we've seen in the last 3 years where we had many other initiatives in place. So the opportunity is still there. It's a journey. It's going to be done region by region. And we believe that we're going to be able to incrementally improve margins quarterly and annually for the most part.

[Operator]

Your next question comes from the line of Frederic Bastien from Raymond James.

[Frederic Bastien, Senior Vice President]

I was wondering if you could give us an idea of where you're seeing the best opportunities for M&A growth beyond your company-owned initiative. Is it still on the fire protection side?

[D. Scott Patterson, CEO, President & Non]

Fire protection and FirstService Residential is certainly a focus for us. In addition to the company-owned, it would be those 4 areas, tuck-unders in every case, as opposed to new business lines or new service lines. But really no change from the past few quarters in terms of our pipeline, and those would be the 4 principal areas.

[Frederic Bastien, Senior Vice President]

And Scott, how easy is it to get that incremental growth out of FirstService Residential? You are obviously the biggest fish in the pond there. Are you still seeing some good opportunities to affect some changes there and do some more tuck-ins?

[D. Scott Patterson, CEO, President & Non]

Yes, absolutely. There are thousands of management companies. We've made tuck-unders every year since we started in this business in '96, and we expect we'll make tuck-unders every year in the future. They are certainly periodic, and they include management companies. As I've said in my prepared remarks, that will primarily add market share to leadership positions in existing markets. But also, ancillary service companies, and I think we have a lot of room there to add, to fill out our service offering in various markets through ancillary service companies.

[Frederic Bastien, Senior Vice President]

And I guess we've discussed in the past your focus on North America. Is it still sort of the area of focus? Is there a -- do you discuss the possibility of going abroad?

[D. Scott Patterson, CEO, President & Non]

Well, we are open-minded to it. Over the years, we've looked at a number of opportunities, but it's not active for us today. We feel like we have -- at 7% market share or thereabouts, we feel like we have lots and lots of running room in North America in this business.

[Frederic Bastien, Senior Vice President]

Okay. The last one for me, it's just I was curious here. I was browsing through the FirstService Brand's website this morning. I noticed a business that wasn't previously aware of, Brandpoint Services. Can you speak to that business there?

[D. Scott Patterson, CEO, President & Non]

Sure. When you see Brandpoint, think of [ Serva ] National, which is what the name used to be. And it is a business which -- business development primarily -- it is the primary focus, looking for national paying contracts, retailers that are national, other businesses which have locations across North America, and then Brandpoint serves as the point, if you will, pulling together these sort of franchisees to deliver the service.

[Operator]

Your next question comes from the line of Stephen MacLeod from BMO Capital.

[Unknown Analyst]

This is [indiscernible] filling in for Stephen. Just the first question I have is, in terms of the seasonality of the recent acquisitions, how much of a contribution were they in the quarter?

[Jeremy Alan Rakusin, Chief Financial Officer]

In terms of margin?

[Unknown Analyst]

Margin, yes, or the portion of the acquisition growth.

[Jeremy Alan Rakusin, Chief Financial Officer]

Well, the acquisition growth, we spoke to earlier. About half of the FirstService Residential growth was acquisitions and half was organic. And in the case of FirstService Brands, we had 10% organic growth and 24% all-in growth, so 14% acquisition growth. In terms of the impact on margins, roughly, on the FirstService Residential side, the seasonality and the mix, about 50% of the margin improvement was operational and about the other half being due to the mix on acquisitions coming in. And on the FirstService Brands side, where there was 60 basis points of margin expansion, most of it would have been acquisition-driven on the margin expansion front.

[Unknown Analyst]

Okay. And has your outlook for the margin for each of the segments changed for the full year?

[Jeremy Alan Rakusin, Chief Financial Officer]

No. I mean, aside from the adjustments driven by the revenue recognition change, everything else would be in line with our expectations at the beginning of the year.

[Unknown Analyst]

Okay. And just the last one for me. Could you provide an update on the Grand Rapids and Phoenix Manufacturing facilities? And how those are progressing in terms of getting operating efficiencies out of them?

[D. Scott Patterson, CEO, President & Non]

I think that we're progressing well on track. Grand Rapids, we opened last year at around this time. And recently, we added a second line. And we're in the process of moving our Massachusetts-owned facility to Grand Rapids. And so capacity utilization is expanding. And we'll look to add our Florida operations to the Grand Rapids facility later this year. And then Phoenix, we -- our 2 lines moving to 3 lines, and we'll be focused for the balance of the year in transitioning our Orange County operation, which is a substantial one. And that will, in both cases, take our capacity utilization up towards 75%-ish. And then it's onward from there. We look to have 5 lines in both and supporting at least 25 operations when we're through.

[Operator]

Your next question comes from the line of Marc Riddick from Sidoti & Company.

[Marc Frye Riddick, Research Analyst]

I wanted to touch on the labor picture at the moment. I just wonder if you could sort of give us some more -- it could be a broad overview, so maybe what you're seeing with labor? And if there are any particular pockets that are maybe a bit more challenging, either geographically or by service line. And then I have a follow-up to that.

[D. Scott Patterson, CEO, President & Non]

The labor market remains very tight and a challenge. And I think I've mentioned in prior quarters that we have open positions really across the board at every business. We are primarily a labor-based company: 19,000 employees, 75% plus of our cost structure is labor. So it remains a challenge. We have invested significantly in recruiting and onboarding over the last couple of years, and we're seeing the results of that in our ability to bring on -- talent has certainly improved, but it does remain a challenge.

[Marc Frye Riddick, Research Analyst]

Okay. And then switching gears over to residential for a moment. I was wondering if you could sort of give us a bit of an update on some of the efforts that have been underway on the renewals, and I guess sort of that discipline around the pricing around renewals in the residential area, sort of where you think you are on that process, and how much room do you think there is for upside on that.

[D. Scott Patterson, CEO, President & Non]

I would describe it as a process. It's really just a increased discipline on our part in terms of approaching renewals and ensuring that we're allocating our labor effectively. It's a very price competitive business. And if on renewal, we believe we're not getting the price that we should, that gives us an adequate margin, we may look to reallocate that labor. And we're being very conservative about it. But what you've seen over the last couple of years and what we've talked about on several occasions is that it served to bring our retention rate down a couple of points to the 93%, 94% level, but it's also played a big part in our margin. And Jeremy referenced client accounting, but -- and then 50% being seasonal impact, but a big part of that other 50%, it's not all the client accounting infrastructure. It's allocating that to labor effectively.

[Operator]

[Operator Instructions] Your next question comes from the line of Michael Smith from RBC Capital Markets.

[Michael Smith, Analyst]

Just wondering if you could give us a little bit of color on the growth opportunities around fire protection, your pipeline or adding new services in some of your offices, I guess?

[D. Scott Patterson, CEO, President & Non]

Sure. I didn't reference Century in particular in our prepared comments, but a very strong quarter in fire protection, a continued strength there. And a big part of it is driven by our success in adding service revenues, repair service and inspection revenues. And we've done that largely through recruiting and hiring specific talent in our different offices so that we can introduce that service as a complement to our installation services on the sprinkler and alarm side. We've also had success in winning national accounts and large regional accounts. Particularly since we acquired Century over the last couple of years, it was something that they were starting to work on, and it's really accelerated and it's had a big impact on our organic growth. In terms of acquisitions, working actively with the management team there in the Southeast of the U.S. to target complementary businesses that both expand the geographic footprint, but also add to the service line. And we expect -- and we haven't announced anything in the last couple of quarters, but we expect that we'll close a few tuck-unders this year, so we feel good about it.

[Michael Smith, Analyst]

Good. And just switching gears. Could you give us an idea or just talk about the growth opportunities in Canada? Is it large? Like is it just too small of a market to -- or there's so much more in the U.S.? Or how does it sort of stack up?

[D. Scott Patterson, CEO, President & Non]

Well, in Canada, we have our franchise operations: CertaPro, California Closets, Paul Davis, Floor Coverings, Pillar To Post. We had strong, strong businesses, College Pro, of course. And we're also the leader in residential property management through FirstService Residential. We think we have great opportunities in Canada. And we're actively growing across the board. We -- I mentioned the acquisition of our first company-owned Paul Davis operation in Western Canada, and we expect that -- certainly, we have a target to have a national company-owned Paul Davis operation in this country, and that was our first step towards that effort. So it's -- we've had a lot of opportunities. Did you have any specifics in particular, in terms of the one or the other brands, Michael?

[Michael Smith, Analyst]

Yes. So the Paul Davis, so it was in Western Canada. Was that Alberta, B.C. or...

[D. Scott Patterson, CEO, President & Non]

Alberta. It's the largest. It's our largest franchisee in that region. And the strategy is the same as we've articulated for the U.S., and that is to have a national coverage so that we can approach Canadian national insurance companies and be their #1 service provider.

[Michael Smith, Analyst]

And just on the residential, I know you've got a pretty big presence in Toronto and Vancouver. But those markets are growing quite rapidly. Are you -- is it -- your growth there, is it from winning, like basically taking share? Or basically new builds?

[D. Scott Patterson, CEO, President & Non]

It's both. We're also the leader in Calgary. And I would say, in all 3, new development does augment our organic growth. But first and foremost, our focus is on taking share in existing buildings.

[Operator]

There are no further questions at this time. I turn the call back over to Chief Executive Officer, Mr. Scott Patterson, for final comments. Go ahead, sir.

[D. Scott Patterson, CEO, President & Non]

Thank you, operator. That's all we have on this end. Thank you for joining and we look forward to reporting our second quarter at the end of July.

[Operator]

This concludes today's conference call. You may now disconnect.