FirstService Corp

TSX:FSV

Earnings Call Transcript 2023-Q2

[Operator]

Good day and thank you for standing by. Welcome to the Second Quarter Investors Conference Call. Today’s call is being recorded. Legal counsel requires us to advise that discussion scheduled to take place today may contain forward-looking statements that involve known and unknown risks and uncertainties. Actual results maybe materially different from those – any other 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 July 27, 2023.

I would now like to turn the call over to Chief Executive Officer, Mr. Patterson. Your line is open.

[Scott Patterson, Chief Executive Officer]

Thank you, Lisa. Good morning, everyone. We appreciate you joining our 2023 second quarter conference call. I am on the line today with Jeremy Rakusin, our CFO. I’ll kick us off with some high level comments and Jeremy will follow with more detail.

As you saw this morning, we reported very strong results that reflect continuing trends and momentum that drove our Q4 of last year and the first quarter of this year. Total revenues for the quarter were up 20% over the prior year, with organic growth at 15%. EBITDA was up 30%, reflecting a margin of 10.6%, which is an 80 basis point improvement over the prior year. Similar to our previous two quarters, outsized organic growth in our Brands division boosted our top line and led to enhanced margins from operating leverage. Earnings per share for the quarter were also up 30%, in line with the increase in EBITDA.

Let me move to highlights for each division, starting with FirstService Residential, where revenues were up 13% in total, with the organic growth again hitting double-digits at 10%. As I stated in my Q1 comments, we entered this year with momentum from strong sales in the fourth quarter of ‘22, combined with solid client retention. This favorable momentum continued through our Q2. The other trend that is helping us in terms of a year-over-year comparison is an increase in labor and services, with many of our larger cost plus contracts. We have reduced the number of contracted, but unfilled positions compared to a year ago, which increases revenue in a cost plus environment. Looking forward to the last half of the year, we expect to show similar low double-digit top line growth for FirstService Residential, with organic growth at a high single-digit level.

Moving on to FirstService Brands, revenues for the quarter were up 27%, with organic growth at 20%, driven by very strong results at our restoration brands and supported by solid double-digit growth at Century Fire and our home improvement brands. Our restoration brands, Paul Davis and First Onsite together recorded revenues that were up over 40% versus the prior year, with about two-thirds of the growth generated organically.

We booked approximately $35 million from named storms during the quarter, split between Hurricane Ian and Winter Storm Elliott. This is down from $75 million plus in Q1, but significantly higher than storm-related revenues in Q2 of last year. We’re pleased with the performance from our restoration brands in Q2. Sequentially, relative to Q1, we generated less than half the storm-related revenue but booked approximately the same total revenue for the quarter, which reflects positively on our day-to-day activity levels across our branch network. Excluding storm-related revenue, we generated solid double-digit organic growth in restoration for the quarter.

Looking forward in restoration, we expect to show continued year-over-year growth for Q3, but at a more modest level than we have seen in the past three quarters. Our backlog is solid and above prior year’s level. A portion of the backlog is reconstruction work related to Hurricane Ian. Much of this work is slow moving, while we wait on permits or engineering studies or insurance confirmation or materials. The work will be completed over the next year as hurdles are cleared and issues resolved. The backlog excluding this portion is approximately at prior year’s level. At this juncture, we expect to show year-over-year growth of 10% or more for Q3 somewhat dependent on the amount of Ian related reconstruction that gets completed between now and September 30.

As I mentioned earlier, we’re pleased with the level of day-to-day work we’ve been securing through our branch network and expect a solid finish to our year in restoration. Moving to Century Fire, we had a strong quarter, right in line with our expectations, low double-digit organic growth against a tough comparative quarter in the prior year. All our branches and service lines continue to perform, and we expect similar results for the balance of the year. The year-over-year growth rates will moderate in Q3 and again in Q4 due to the strong sequential growth we were generating from quarter-to-quarter throughout 2022.

And I’ll finish with our home improvement brands, which as a group were up over 10% versus the prior year with high single-digit organic growth. This is an impressive result and a real credit to our operating teams. The home remodeling sector in general is facing headwinds from higher interest rates and very sluggish home resales. Our leads continue to lag year-ago levels but a heightened focus on lead conversion and closure ratio is enabling us to continue to drive growth. Looking forward, we expect the environment to remain difficult, but our teams believe they will continue to generate at least mid to high single-digit growth through the back half of the year.

Let me now ask Jeremy to review our results in more detail. Jeremy?

[Jeremy Rakusin, Chief Financial Officer]

Thank you, Scott and good morning everyone. We are very pleased with our second quarter financial results, which yielded strong year-over-year growth metrics that closely matched our prior Q1 performance in every respect. On a consolidated basis, revenues for the quarter were $1.12 billion, up 20% year-over-year and driving to adjusted EBITDA of $118.4 million and adjusted EPS of $1.46, both up 30% versus the prior year. Our 6 months year-to-date consolidated financial performance included revenues of $2.14 billion, an increase of 21% and over the $1.77 billion last year, with the contribution from organic growth at 16%.

Adjusted EBITDA of $200.4 million, representing 30% growth over the $153.7 million last year with a margin of 9.4%, up 70 basis points from the 8.7% in the prior year period; and adjusted EPS at $2.31, up 25% over the $1.85 per share reported during our same 6-month period last year. Our adjustments to operating earnings and GAAP EPS to calculate our adjusted EBITDA and adjusted EPS, respectively, have been summarized in this morning’s release and remain consistent with disclosure in prior periods. I’ll now break down our division financials for the second quarter. Beginning with FirstService Residential, quarterly revenues came in at $517 million, up 13% over the prior year.

EBITDA for the quarter was $55.7 million, a 10% year-over-year increase with a 10.8% margin, down a modest 20 basis points from the 11% margin in Q2 of last year. We expect the division margin to be relatively flat to prior year in the remaining half of 2023, which would result in our full year margin being closely in line with our 2022 annual performance. At our FirstService Brands division, we reported second quarter revenues of $603 million, a 27% increase over the prior year period. EBITDA for the quarter came in at $65.8 million, up 50% year-over-year. Our margin during the quarter was 10.9%, up 160 basis points over the 9.3% during last year’s Q2.

As Scott previously outlined, our restoration operations benefited during the current period from elevated weather-related storm activity compared against the dormant level in the prior year second quarter. This contribution from our restoration platform was the primary driver behind both the higher division top line growth and margin improvement versus prior year, just as we saw in Q1. For the upcoming third quarter, we expect the Brands division margin to be more in line with prior year with anticipated tapering in contribution from storm backlog conversion within restoration compared to the first two quarters of this year. With the Brand’s margin improvement we have booked year-to-date, we expect to finish the year with annual division margins up versus 2022.

Moving below the operating earnings line. Our earnings per share of $1.46 during the quarter benefited from a non-recurring $0.07 per share related to a gain on sale of an owned building. This gain helped offset higher year-over-year interest expense to drive to our 30% adjusted EPS growth, matching our EBITDA growth for the quarter. Looking at our cash flow from operations, we delivered $86 million, up 40% over the prior year quarter. More than half of the increase came from earnings growth across both divisions. And then we also benefited from working capital movements, which in the current quarter delivered a slight cash inflow versus a more typical cash requirement as seen in last year’s Q2.

With respect to capital expenditures, we invested $23 million during the quarter in support of our existing operations and our year-to-date total of $44 million is pacing with our targeted full year maintenance CapEx of $80 million and overall spending of approximately $100 million. Tuck-under acquisition activity during the quarter was tempered with minimal capital deployment. But with year-to-date investments approaching $100 million, recent acquisitions will contribute to our growth during the upcoming quarters. In closing our financial review, our balance sheet remains very strong. Leverage, as measured by net debt-to-EBITDA moderated to 1.6x, down from 1.8x in the prior first quarter. Liquidity, reflecting total undrawn availability under our revolver and cash on hand remains ample at approximately $420 million.

Our conservative capital structure and financial flexibility allow us to be assertive as we keep our eyes open for opportunities to deploy capital. Looking forward, the strong year-to-date performance we have booked thus far reinforces our conviction that our businesses will collectively deliver low teens consolidated revenue growth with our consolidated EBITDA margin being roughly in line to potentially a little higher than our annual 2022 level.

That concludes our prepared comments. Lisa, you may now open the call to questions. Thank you.

[Operator]

Thank you. [Operator Instructions] The first question that we have today is coming from Stephen MacLeod of BMO Capital Markets. Your line is open.

[Stephen MacLeod, BMO Capital Markets]

Great. Thank you. Good morning, guys. Just a couple of questions. I just wanted to start with the residential business. Just curious if you can give an outlook or an update on sort of what you’re seeing in terms of pricing? And I guess as you have some of these fixed price contracts coming up for renewal, what’s the ability or what’s the outlook for passing through some of those prices?

[Jeremy Rakusin, Chief Financial Officer]

Stephen, I’ll take that one – go ahead, Scott.

[Scott Patterson, Chief Executive Officer]

Yes. Okay, Jeremy. It’s an ongoing exercise, Stephen. We’re having contracts renew throughout the year. As you know, it has been and always will be a price-competitive market. It’s generally how our smaller competitors compete against us. So – we remain in an inflationary environment. And while wages have stabilized, we’re still seeing increases as contracts renew, we need to cover off these increases. In some cases, we’re getting that increase. In some cases, we’re not – we’re getting part of it. We’re getting over a period of time. So I’ve talked about in the last several quarters, it’s a balance for us between margin and organic growth. And I think that will continue. We are, I think, right now probably at about 3% in terms of price increases, 10% organic for the quarter, 3% of that would be price. And I think that’s the level we will be at for the foreseeable future.

[Stephen MacLeod, BMO Capital Markets]

Okay. That’s great, thank you. And then maybe just on the home improvement side of things. You talked a little bit about you’re sort of seeing the home remodeling sector facing headwinds, but still expecting mid to high single-digit growth through the back half of the year. So just curious if you can give a little bit of color as to where that incremental or those pockets of strength are coming from in light of the weaker macro backdrop?

[Scott Patterson, Chief Executive Officer]

Yes. I mean there is a number of things. We see this environment as an opportunity to grab share. So we have invested in marketing. We are carefully using promotion and discount all to drive leads. And then we’re very focused on converting the leads and closing the sale. Our leads are down year-over-year, as I think I said in my comments, but we’re having greater success in converting them and closing them. And certainly, marketing and promotions are helping. The other thing this year is we have a greater capacity in these home improvement brands to complete work with a more stable labor environment. So our productivity has improved. We’re able to schedule work more quickly. All of that is helping with the close ratio.

[Stephen MacLeod, BMO Capital Markets]

Okay, that’s helpful. Thanks, Scott. Appreciate it.

[Operator]

Thank you for your question. [Operator Instructions] And our next question will be coming from Michael Doumet of Scotiabank. Your line is open.

[Michael Doumet, Scotiabank]

Hey, good morning, Scott and Jeremy. My first question is on the residential business. On labor, I wonder, are you at a point where you think you’ve essentially filled the vacancies, maybe call it your kind of like normal vacancy levels, particularly as it relates to fulfilling ancillary services? Just trying to get a sense for the continued momentum of that business on a go-forward basis?

[Scott Patterson, Chief Executive Officer]

Yes, we have. We’re back to historical levels in terms of our open positions. And so we’ve made real progress over the last 6 months. It’s a – we’re in a labor environment that has improved certainly for us and the type of positions we’re trying to fill. So we have seen a little boost to our organic growth the last few quarters. We will probably see it again in Q3, but it’s a temporary boost, and we won’t see it certainly next year.

[Michael Doumet, Scotiabank]

Got it. It’s a bit of a catch-up. You’re – again, for the residential business, I think you are calling for high single-digit growth in the second half versus 10% plus in the first half. If I look at the comps last year, it doesn’t really look like the second half grew much faster than the first half. So, I am just trying to wonder why you are calling for an effective slowdown of the organic comps in the first half versus the second half, particularly given some of the tailwinds here.

[Scott Patterson, Chief Executive Officer]

Yes. I think it’s not a significant decline, but we will see this labor boost. We still – we will see that start to fall off. So, I think we are certainly making an accommodation for that as we guide towards high-single digit. Otherwise, this business is stable month-to-month, quarter-to-quarter. So, we won’t see any big moves one way or the other.

[Michael Doumet, Scotiabank]

Okay. That makes sense. And maybe just a third one for Jeremy, on the working capital side, I think you commented Jeremy, I thought was neutral, typical seasonality is usually it’s a draw, but there has been nearly, call it, $175 million of investment to working capital in the last four quarters. So, just wondering how to think about that, how correlated it should be to restoration activity to the seasonality in the second half?

[Jeremy Rakusin, Chief Financial Officer]

You are right. I mean a lot of the investment in working capital is reflected in accounts receivable and that’s largely driven by our restoration operations. We expect to collect on that in the coming quarters. They are longer paying customers, good paying customers, all backed by insurance. And the timing and as to which quarter it’s going to come in, it’s hard to predict and obviously also dependent on further weather-driven activity in coming quarters. So, the timing is always around working capital, as I said, is very tough to predict quarter-to-quarter. It’s – we feel comfortable that we are going to convert it. And I think you saw the start of that in this quarter with some of our other working capital items swing to the positive.

[Michael Doumet, Scotiabank]

Perfect. Very nice quarter, guys. Thanks for the answers.

[Operator]

[Operator Instructions] And our next question will be coming from Tom Callaghan of RBC. Your line is open.

[Tom Callaghan, RBC]

Thanks. Good morning guys. Maybe just to start on the restoration side and going back to your prepared remarks there, you mentioned in Q2 that total revenue was really the same despite kind of that lower booked amount of storm revenue in Q2. Can you maybe just talk about some of the positive drivers of that day-to-day activity? And is it broad-based, or is there something specific driving that?

[Scott Patterson, Chief Executive Officer]

Well, between the two brands, we have 430 branches or 440 branches. So, we are positioned across North America. While there weren’t any named storms in the first six months, there was widespread weather really throughout North America. And so our branch network benefited from that. We are responding well to our customers, the national commercial and insurance carriers. And I think we are building on and improving our service delivery. We feel like we are getting more wallet share. So, it’s just day-to-day organic growth across the branch network. The other thing I will say is that we did benefit from a few very large projects that were not storm related. We are in the business of large loss, principally through FirstOnSite, and we always have large losses on the go, but we did get a boost in Q2 from a few particularly large jobs.

[Tom Callaghan, RBC]

Got it. That’s helpful. And then maybe just one more from me on the M&A front. Maybe just talk about what you are seeing in the pipeline? And then any commentary on any evolution of pricing valuations thus far in 2023?

[Scott Patterson, Chief Executive Officer]

Sure. Our pipeline is steady, and I would say it reflects a normal level of activity for us. We didn’t close anything in the quarter, but we do have deals in process. And they really are – I think I said in the last quarter, there are typical tuck-under family-owned business. I would say that the deal flow has slowed. The availability of companies has decreased. I think it may be because owners believe multiples are down or competition has moderated, but we haven’t seen that. Good businesses are attracting multiples as high as they have ever been. And good businesses are attracting many bids. So, it’s a – I don’t think the valuations have changed. We haven’t seen it, and I think the deal flow is off a bit. But I would expect us to close some of our pipeline between now and year-end.

[Tom Callaghan, RBC]

Okay. Great. That’s it for me. I will turn it back.

[Operator]

Thank you. [Operator Instructions] And our next question is coming from Matthew Filek of William Blair. Your line is open.

[Matthew Filek, William Blair]

Hey Scott and Jeremy, you have Matthew Filek on for Stephen Sheldon. Thank you for taking my questions. I wanted to start with one on residential. What is the pace of new HOA construction meant to growth in the Residential segment? Is that becoming a bigger component of organic revenue growth by giving you newer properties to pursue?

[Scott Patterson, Chief Executive Officer]

I would say new development for us, Matt, has always been a stable component of our growth, but it’s probably off right now compared to the last 5 years. We have always given the number that average is about 20% of our growth, and that’s where it is right now, I would say, but thereabouts. But it has been stronger, I think in the last few years. But we do – it’s a core part of our strategy, and we have strong relationships with developers across North America, particularly high-rise and large lifestyle communities. Does that answer your question?

[Matthew Filek, William Blair]

Yes, that’s helpful color. Thank you for that. And then I was just looking for an update on the restoration technology platform and how that’s progressing relative to your expectations? And what that platform could mean for margins in the Brands segment and if it could move the needle any?

[Jeremy Rakusin, Chief Financial Officer]

Yes. Hi Matt, it’s Jeremy. I will take that one. Making continuous progress, I said on our last call, we were approaching the halfway mark. We are a little more than that. So, it’s steady, on track. We have got many branches still to onboard and any benefits that we are going to see from that is – will only start to incrementally realize on that at some point in ‘24 and beyond. Multiyear effort, hard to quantify until we have kind of completed getting everyone on one system and going to market with one brand in terms of processes that are consistent and systematic across the board.

[Matthew Filek, William Blair]

Got it. That makes sense. And then just a quick clarification question here, and forgive me if I missed this, but how should we think about the impact from weather in the third quarter relative to levels seen in the second quarter, assuming no other named weather events come through?

[Scott Patterson, Chief Executive Officer]

It will be down quite a bit. We are through most of our backlog from Ian and winter storm Elliott. So, we will see some, but down materially from Q1 and Q2.

[Matthew Filek, William Blair]

Okay. Got it. Thank you, both and great quarter.

[Scott Patterson, Chief Executive Officer]

Thanks Matt.

[Operator]

Thank you for your questions. At this time, I am showing no further questions in the queue. I would like to turn the call back over to the CEO for closing remarks. Please go ahead, sir.

[Scott Patterson, Chief Executive Officer]

Thank you, Lisa. And thank you all for joining today. Enjoy the rest of your summer, and we will regroup for Q3 at the end of October.

[Operator]

This concludes today’s conference call. Thank you all for joining. You may all disconnect and please have a great day.