FirstService Corp

TSX:FSV

Earnings Call Transcript 2019-Q1

[Operator]

Welcome to the first quarter investors conference call. Today's call is being recorded. Legal counsel requires us to advise the discussion scheduled to take place today may contain forward-looking statements that involve known and unknown risks and uncertainties. Actual results may materially differ from any future results, performance or achievements contemplated in the forward-looking statements. Additional information concerning factors that could cause 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 24, 2019. I would now like to turn the call over to the Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

[D. Scott Patterson]

Thank you, Denise. Good morning, and welcome, ladies and gentlemen, to our first quarter conference call. Thank you for joining today. This morning, we announced strong results for the first quarter, driven by double-digit top line growth at both of our divisions. We're very pleased with the way we have started the year, which sets us up to achieve our full year objectives. I will spend the next few minutes taking you through some of our highlights, and then Jeremy will follow with a financial review and a look forward.Revenues for the quarter were up 14% over the prior year, with organic growth accounting for half of the increase and the balance from numerous tuck-under acquisitions closed over the last year in both divisions.EBITDA was up 15%, with margins approximately flat with the prior year. Year-over-year margin enhancement at FirstService Residential offset by a margin dilution at FirstService Brands. Jeremy will walk you through the margin detail in his prepared comments. And finally, our earnings per share increased by 20% over Q1 of 2018. At FirstService Residential, our revenues were up a strong 12%, with the organic growth at 6.5%. The organic growth was driven by sales activity and contract wins in the last half of 2018, with particular strength in California, Nevada, Arizona and New York. The increases in management fees were supported by solid growth in ancillary services revenue. Revenue growth benefited from the addition of 4 notable tuck-unders over the last 6 months. In November, we announced the acquisitions of Condominium Concepts Management, with operations in Atlanta and Nashville; and also Community Management Group based in Charleston, South Carolina. I mentioned these transactions in our year-end call and noted the strategic importance of increasing our share in Atlanta and expanding our leadership to Nashville and Charleston.And earlier this year in February, we announced 2 acquisitions in Chicago. Lieberman Management Services and the condo management division of Draper and Kramer. Lieberman is the leading company in the greater Chicago area, and Draper and Kramer is the gold standard for high-rise management in the downtown core. Together, they significantly increased the size of our client base in Chicago and established FirstService Residential as the dominant leader. Each of these 4 acquisitions are important strategic additions for us, and we are very pleased to welcome these organizations in the FirstService family. The acquisitions and organic growth over the last year take us to 8,500 communities under management, comprising 1.7 million units. Turning now to FirstService Brands, we posted another quarter of strong revenue growth, up 17%, including 7% organic growth. Organic growth was driven by strong activity at our home improvement brands, including California Closets, CertaPro Painters and Floor Coverings International. Home improvement spending in North America continued its strong levels in Q1 and these 3 brands benefited, growing on average at a low double-digit rate.Organic growth for the division was tempered by a year-over-year revenue decline at Paul Davis Restoration. The decline was largely due to reduced activity levels at Paul Davis National, our commercial large loss operation. We came off a very strong back half of 2018, driven by a number of weather-related events. Our claim activities slowed considerably into Q1 and was down on an organic basis close to 10% compared to prior year levels. Overall growth at Paul Davis was up for the quarter due to 4 tuck-under acquisitions made over the past year in advancement of our company-owned strategy. We now own 10 operations in total towards our objective of creating a national company-owned platform that provides a consistent service offering to national insurance carriers. Top line growth for the FirstService Brands division was also enhanced by tuck-under acquisitions at California Closets and Century Fire. We added 4 operations at California Closets that impacted the quarterly revenues, including 2 that we announced during the quarter, Baltimore and South New Jersey. These most recent additions bring us to 19 California Closets company-owned operations. At Century Fire, we also had 4 tuck-unders over the last year that impacted the quarter. In addition, we announced another 2 tuck-unders last week, Advantage Fire Sprinkler in Atlanta and Chief Fire Systems in Houston. Our stated strategy when we partnered with the Century team in 2016 was to broaden our service line and expand our geographic footprint in the Southeast. In the 3 years since, we have made 7 tuck-under acquisitions in advancement of that strategy, while also driving high levels of organic growth. We remain very excited with our progress to date and future opportunity in the fire protection market. As I mentioned at the outset, we had a solid start to the year and feel good about our prospects for the balance of 2019. 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 you just heard from Scott, we reported another quarter of strong results. The financial details are disclosed in this morning's press release that I will highlight -- I will hit the highlights around our quarterly consolidated and segmented financial performance, our cash flow and capital deployment and finish with our balance sheet. To summarize our consolidated first quarter financial results, FirstService reported revenues of $486 million, up 14% over the $426 million in the prior year quarter. Adjusted EBITDA was $29.2 million, a 15% increase over the prior year's $25.4 million, with our margin coming in at 6% in line with Q1 2018. And our adjusted EPS was $0.30, representing 20% growth over the $0.25 per share reported for the same period last year. Our 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 point to note before turning to our segmented performance is a new U.S. GAAP lease accounting standard in effect as of January 1, 2019. This accounting change requires all operating leases to be capitalized on the balance sheet. The effect on FirstService is an increase on both the assets and liabilities side of our balance sheet of approximately $100 million with no significant impact on our shareholders' equity. I also want to emphasize that this accounting change has no impact on our income statement or cash flow statement. As reflected in this morning's press release, we've isolated the liability entries relating to these capital leases in separate line items within the balance sheet and will continue this practice going forward. These capital leases will not be included in our debt and leverage calculations so as to maintain consistency with the methodology and metrics reflected in all periods prior to this accounting change.Now I'll walk through our divisional highlights for the quarter. Kicking it off with FirstService Residential. We generated revenues of $319 million, up 12% over last year's first quarter and driven equally by organic growth and recent tuck-under acquisitions. EBITDA was $21.8 million, a 25% increase over the prior year and resulting in a 6.8% margin, up 60 basis points versus last year's 6.2% margin. The margin expansion was largely driven by tuck-under acquisitions within the division over the past year, in particular property management operations and amenity services businesses with year-round operations. These recent additions increased the contribution of our nonseasonal businesses in what is our seasonally weakest first quarter, amplifying the margin profile of the division for Q1. We do not anticipate this level of margin improvement in future quarters of 2019. Now on to our FirstService Brands division, where we recorded revenues of $166 million during the first quarter, up 17% over last year's first quarter, with strong organic growth from our businesses tied to home improvement and remodeling spending and solid contribution from recent tuck-under acquisitions across our company-owned platforms. EBITDA came in at $11 million, down slightly from $11.2 million in the prior year quarter. The division margin declined to 6.6% from the prior year's 7.8% level. And as Scott alluded to, the principal driver was our Paul Davis company-owned platform, 2 factors specifically: first, lower weather-related activity levels, which meaningfully impacted year-over-year revenue and profitability; and second, ongoing investments in the Paul Davis company-owned platform and shared services infrastructure to support future organic growth and the addition of other tuck-under candidates.Taking a look now at our cash flow. We delivered $24 million before working capital changes, up modestly versus last year. Operating cash flow after working capital requirements came in at a very strong $25.6 million, up more than threefold over Q1 2018. Typically, the first quarter is our seasonal trough, which sees increased working capital usage. However in the current quarter, we were able to more than offset this trend by converting some of the growth-related working capital we saw during the latter part of 2018 into cash. Capital spending during the first quarter was a little over $10 million, right in line with the prior year quarter. This keeps us on track with the previously forecasted 209 -- 2019 CapEx requirements of $45 million. The first quarter was also another active period with our tuck-under acquisition program. We incurred $25 million of acquisition spending largely to add scale to our FirstService Residential, property management operations in Chicago and to further advance our California Closets company-owned strategy. Our deal pipeline remains robust, particularly with regard to service lines with company-owned operations in our Brands division. Finally, on our balance sheet, we ended the quarter with net debt of $311 million and a 1.6x leverage ratio measured at net debt to trailing 12 months' EBITDA. These debt metrics kick higher compared to our 2018 year-end, which is a typical trend, given the seasonally lowest cash flow first quarter combined with the solid level of capital investments deployed during the period.In addition, after quarter end, as disclosed in our press release 2 weeks ago, we bolstered our balance sheet, increasing our $350 million revolving bank credit facility by $100 million to provide us with total capacity of $450 million under our bank revolver. With our facility currently drawn down by $240 million, our liquidity in terms of undrawn credit facility balance and cash on hand sits at $280 million. Our leverage is conservative, particularly for our recurring cash flow business, and we have ample financial capacity and flexibility to accommodate all of the attractive opportunities and capital requirements to support growth across our businesses. With a strong quarter under our belt, which saw balance contribution from organic growth and our tuck-under acquisition program across both our Residential and Brands divisions, we feel positive about the prospects for the balance of 2019 and our ability to deliver on our full year targets. That concludes prepared comments. I would now ask the operator to open up the call to questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from Stephen Sheldon with William Blair.

[Stephen Hardy Sheldon, Analyst]

First, great to see the continued expansion into the fire protection business. But given that it's becoming a bigger portion of the Brands segment, can you maybe help us frame the transaction versus more recurring component for some of the recently acquired assets in Atlanta and Houston and maybe also a view of the overall transaction versus recurring split within the broader fire protection business?

[D. Scott Patterson]

Sure. The acquisitions have been a mix and include companies that weighed towards alarm capability and others which weighed towards sprinkler. And our goal with all these acquisitions is to create a full service fire protection company. So we will layer in alarm capability where it isn't and sprinkler and fire extinguisher where it isn't. And we continue to do that with the Century locations also. We started out at about 55% of our revenue in the aggregate installation and tied to new construction. And our goal was to derisk in that area and diversify. And today, we're closer to 45%. And in part, that is a result of the hard work that, that team is taking on in terms of growing the service side of its business and the national account program. Net-net, the acquisitions have probably come in about 50-50, although I -- we haven't looked at that exact calculation.

[Stephen Hardy Sheldon, Analyst]

That's great and very helpful. I guess -- and then on the margin within the Brands business, you noted some drag from the company on Paul Davis operations. Can you elaborate on that some more? Was that just lower leverage of fixed costs as broader restoration activity has trended down some? And then, I guess, along those lines, how do you think about managing the cost structure for swings in restoration activity?

[Jeremy Alan Rakusin, Chief Financial Officer]

Stephen, yes, the -- as mentioned, there were 2 factors. I mean we are looking to grow this platform, the company-owned operations and get in front of future surges in activity levels. So we're adding headcounts across all of the company on operations to drive future growth there. And then also the shared services platform, which pulls all of those operations together and a lot of the back-office functions, we needed to build that from scratch not only to support the 10 that we have today, but future ones that we plan on acquiring. So yes, it's negative operating leverage. If we have periods like we did in the first quarter where we had lulls and storm and other activity level, it's going to affect the profitability. This business, out of all the ones that we own, are tougher to predict on a quarterly business because -- on a quarterly basis, because they are driven by weather-related activities. So we may have to deal with the volatility from quarter-to-quarter. But we love it over the long term in terms of the secular growth and some of the other macro aspects that drive the long-term growth trend of this business.

[Operator]

Your next question comes from Stephen MacLeod with BMO Capital Markets.

[Stephen MacLeod, Analyst]

I just wanted to circle around on the credit facility. Obviously, a big increase or $100 million increase. Can you just talk a little bit about is that indicative of your anticipation that the acquisition activity will increase? Or is it more in the normal course of business? And then, I guess, along those lines, can you just talk about what the pipeline looks like both on the FSR side and the FSB side?

[D. Scott Patterson]

Stephen, I'll start on the latter part of the question, the pipeline, and I'll pass it over to Jeremy for the credit facility question. The pipeline, Jeremy mentioned in his prepared comments, it remains robust and it -- certainly it does, I'd say, primarily on the Brands side with the California Closets and Paul Davis company-owned initiatives. We closed a number of deals, as you know, in the last 6 months in fire protection, California Closets and with FirstService Residential. We would not expect to be as active in the next 6 months as those teams are busy integrating and onboarding. But we remain active on the Paul Davis side, and those platforms will pick up towards later in the year or next year.

[Jeremy Alan Rakusin, Chief Financial Officer]

And Stephen, just on the credit facility, we just think it's prudent again we speak about financial strength and flexibility. It's one of our key pillars and maintaining sufficient headroom so that we can execute on not just the internal growth initiatives, but also the acquisitions and the pipeline that Scott just spoke to. We want to make sure we have significant headroom to execute on those. As our businesses get bigger, they command a little more working capital. And you saw some of that being deployed in Q1, and we just thought now was the time to simply upsize and give us more headroom. But it doesn't necessarily foreshadow any unusual or stronger level of acquisition pipeline than what we've seen in the last year continuing to tick along with our program.

[Stephen Hardy Sheldon, Analyst]

Right. Okay. That's great. And then just turning to the FSR business, I know you mentioned some of the contributors in your prepared remarks. But I'm just curious, was anything else unusual contributing -- not unusual, but anything noteworthy that's contributing to that strong FSR organic growth of 6% in the quarter? And then how do you expect that number to trend as you cycle through the year?

[D. Scott Patterson]

Right. I've mentioned in the past few calls that we target larger communities, whether they be high-rise or active adult master plan communities that require more staff and more complex service requirements and generally where we are able to differentiate ourselves in a more compelling way. And we won several of those in the last half of 2018 that have luxury amenity components to them, lifestyle, staff, food and beverage, more complex communities and service requirements. And so certainly, that helped inch our organic growth at this quarter. I would also say that on the ancillary side, we had solid growth, and I would highlight early season repair and construction in our pool maintenance business relative to the prior year. This level of organic growth is amplified in our seasonally lower Q1, and the same level of revenue in our seasonally stronger Q2 or Q3 will have a lower impact. So I would think mid-single digits, Stephen.

[Stephen Hardy Sheldon, Analyst]

Okay. That's helpful. And then, I guess, just finally on the FSB business, I understand that there's some seasonal aspects around that margin in the quarter around PDR. I guess notwithstanding the fact that it's harder to predict, when you look at how PDR comps against last year, do you see any other major unusual items that would cause the margin to swing either notably higher or lower as you get through the year?

[D. Scott Patterson]

Well, the activity -- claims activity in Q1 across our own footprint, which is primarily Mideast, Mid-Atlantic, Northeast Florida, has been lower than the prior year. And in addition, a large loss claim activity has been lower than the prior year. We expect a similar comparison in Q2. And so for the same reasons that Jeremy outlined in terms of the negative operating leverage, we think Q2 will be similar. But then we get into different hurricane seasons and so on. So Jeremy laid it out very well, this is a weather-driven business and the upside means that it's not tied to economic cycles or housing cycles, but the downside means it's inherently volatile. So Q2, I think we have some visibility. But beyond that, it's hard to say.

[Operator]

Your next question comes from Matt Logan with RBC Capital Markets.

[Matt Logan, Senior Associate]

Just on the macro environment, can you talk a little bit about the impact, if any, slowing housing starts and home price gains are having on the business?

[D. Scott Patterson]

We saw Q1 being similar to Q4. Existing home sales down year-over-year, but the -- but prices do continue to rise, but albeit at a slower level. And net-net, that continues to bolster home improvement with increasing home equity being a principal driver. So we -- it maintained a level of strength in the first quarter. I'm not -- we're not expecting it to maintain that same level of strength through to the end of '19 and into '20, but we haven't seen any slide yet. But we're cautious, I would say, in terms and watching our leads very carefully.

[Matt Logan, Senior Associate]

That's good color. Maybe just changing gears, you launched your California Closets e-commerce platform during the quarter. Would you mind giving us a little bit of color on the digital strategy for the business as well as the company as a whole?

[D. Scott Patterson]

Sure. First of all, we're very excited about it. And the e-commerce line really relates to accessories. And historically, we have designed and installed closets, but not had the capability to fill -- fit that closet out with accessories like hangers and storage bins and mirrors and so on. And our customers have had to go to retail outlets or even to competitors to fit out their closets. So first and foremost, we have that capability now, and we're able to provide a better, more comprehensive experience to our customers, which will drive up our average job size, we believe, and generally enhance the brand. The digital side of it is really an opportunity for us to seamlessly serve them and maintain an ongoing touch point with our customer and create convenience for them. But I think first and foremost, it's our ability to provide the accessories and fill out our line.

[Matt Logan, Senior Associate]

And do you see opportunity to add more e-commerce platforms for other aspects of the business or other brands?

[D. Scott Patterson]

Beyond California Closets?

[Matt Logan, Senior Associate]

Yes.

[D. Scott Patterson]

It's not front and center strategically, Matt. We'll be watching this closely.

[Matt Logan, Senior Associate]

And as we look at the Brands business, as it evolves with more tuck-under acquisitions for fire and for Paul Davis Restoration, how do you see the general revenue or EBITDA mix of the business over the next 2 or 3 years?

[D. Scott Patterson]

It will become more balanced, or as we've seen in the last few years, our growth rate on the Brands side has been higher. And it will -- we believe it will continue to be higher in the coming years. So it will start to balance out the margin. We've seen the slow dilution at Brands as we add company-owned. So that will continue as well. The size of the acquisitions will somewhat determine how quickly these divisions balance out.

[Operator]

[Operator Instructions] Your next question comes from Marc Riddick with Sidoti.

[Marc Frye Riddick, Business and Consumer Services Analyst]

I was wondering if you could take me through some of the things that you're seeing on -- from a labor standpoint. And so the tangent to that, I know that you've talked in the past about maybe prioritizing certain offerings or jobs. And so I was just wondering if you could sort of give a little bit of an update to that as to how that's progressing and what you see going forward there.

[D. Scott Patterson]

Okay. In terms of labor, Mark, nothing has really changed over the last year. I mean the labor market continues to be very tight across all our businesses. We continue to focus and invest in recruiting, onboarding and retaining our people. We think we're getting better at it. And it is enabling us to capitalize on the internal growth opportunities that we have across our businesses. We simply can't grow at the level we are if we're not bringing on people. So we're very pleased and proud of how we've responded to the tight labor market with our recruiting and onboarding capability. But it's tough. It's tough out there. I don't know if I answered your question. Is there anything more specific?

[Matt Logan, Senior Associate]

Well, I was kind of thinking about the prioritization part of it. Just from a management perspective, is -- are there certain -- is it sort of on a level of prioritizing certain jobs under certain banners? Or how should we think about sort of those efforts?

[D. Scott Patterson]

Well, I think within Brands, we're careful to allocate the labor as effectively as we can, which leads to pricing discipline. We don't want to take on work and allocate labor to it if we're not going to earn our margin. So there is great discipline, I'd say, across the brands and focus on that.

[Matt Logan, Senior Associate]

Okay. Great. And just one other thing, so to switch gears a little bit toward -- you may have mentioned on fire, and I was sort of thinking about from the national account perspective under that umbrella. I was wondering if you could sort of talk a little bit about -- I think you mentioned in the past, be it retailers or restaurants or what have you, I was wondering if you can give a sense of like on the national folks that you're making some progress with under the fire umbrella. Maybe is there anything in particular about that? Is that a regional thing? Is it a type of business? Maybe sort of take us a little bit through that part of it?

[D. Scott Patterson]

Yes, it's multi-location and retail, restaurants, property management, commercial property management organizations, it's all of the above. And it would include regional networks that overlaps and is consistent with our footprint in the Southeast of the U.S. But it also includes national contracts. And in those cases, we need a very, very strong vendor network to support us.

[Matt Logan, Senior Associate]

Okay. And then a last one from me on the residential side. I was wondering if you could sort of take us through sort of how you're viewing the pricing discipline and sort of maybe what we're seeing on renewals and retention. Certainly, the numbers certainly looked. But I was wondering if you could just give a little bit of additional detail on that part of it on the residential side.

[D. Scott Patterson]

Okay. Really nothing of note on that front. The market remains very price competitive. And I mentioned the allocation of labor and our focus on allocating it effectively. So the increase in that discipline over the last 2, 3 years has resulted in some customers leaving based on price and our retention rate dropping 1 percentage point or 2. We see it ticking back up this year. I think there's sort of stability that has come to the market. But also our sales are strong right now. So it's a combination of those 2 that is benefiting the nudge in organic growth that you've seen.

[Operator]

Since there are no further questions queued up at this time, I turn the call back over to presenters.

[D. Scott Patterson]

Thank you, Denise, and thank you, everyone, for joining us today. We look forward to our second quarter call, end of July. Have a great day.

[Operator]

Ladies and gentlemen, this concludes the first quarter investors conference call. Thank you for your participation, and have a nice day.