FirstService Corp

TSX:FSV

Earnings Call Transcript 2018-Q3

[Operator]

Welcome to the Third 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 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 October 24, 2018.I would like to turn the call over to Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

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

Thank you, Amy. And welcome, ladies and gentlemen, to our Third Quarter Conference Call. Thank you for joining.I'm pleased to be here today with our CFO, Jeremy Rakusin. And together, we will walk you through the strong results we posted this morning and answer any questions you might have.I'll start with a high level review of the numbers and some commentary around our quarterly highlights, and then Jeremy will step in with a more detailed review of the financials.Revenues were up 9% over the prior year, comprised of 5% organic growth; and the balance from tuck-under acquisitions, primarily within our FirstService Brands division. EBITDA was up 13%, driven by the revenue gains and a 20 basis point margin lift at FirstService Residential. And earnings per share were up 22%. 9%, 13% and 22% at the revenue, EBITDA and earnings per share lines, a strong quarter and results that we are very pleased with.At FirstService Residential, revenues grew 5% in total, 4% organically. Organic growth was driven by net new management contract wins and enhanced by healthy increases in ancillary service revenue including seasonal pool maintenance and construction. Growth was balanced geographically, with every region up over the prior year. Our revenue in this division is almost entirely contractual, resulting in a recurring, consistent financial model that does not swing significantly from quarter to quarter or year to year. As you know, our results in this division have been very consistent. We've grown through net new contract wins, and the 2 key variables are contract sales and contract retention. Our focus over the last few years both for sales and retention has been on larger communities with more complex service requirements where we can more clearly differentiate our scale and expertise. These include urban high-rise condos and co-ops, large master-planned and active adult communities. We've been growing at mid- to low single digits over the last few years but suddenly shifting our client base and, we believe, growing a healthier business.Moving on to FirstService Brands. Revenues for the quarter were up 17% versus the prior year, with 6% coming organically; and the balance from 10 tuck-under acquisitions completed in the last year: 5 restoration operations, 3 California Closet operations and 2 fire safety tuck-unders. The organic growth at FirstService Brands was driven by low double-digit increases at California Closets, Century Fire and Floor Coverings International; and supported by high single-digit growth at CertaPro Painters and the franchised operations of Paul Davis Restoration. Divisional growth was tempered by declines at our company-owned Paul Davis National business, which is our commercial large loss operation. We completed several large commercial projects in the third quarter of 2017, which generated outsized revenues for this business relative to our third quarter this year. Organic growth for the division is closer to 10% for the quarter if we exclude the tough comparison at Paul Davis National. One of the side effects of building our company-owned restoration platform, which includes large loss operations, is that we will see swings in our revenue periodically as a result of large losses and/or catastrophic weather events such as Harvey and Irma last year and Florence and Michael this year. These events are episodic and may alter our year-over-year trends even when the broader fundamentals remained intact.Looking to the fourth quarter in this division, we expect continued strong organic growth in our home improvement brands but again expect this to be tempered by flat to down results at our company-owned Paul Davis operations. The claims and activity generated by Florence and Michael won't match the revenues that we generated last year in Florida and Texas primarily due to the relative number of buildings and total loss value in the affected areas. Organic growth should be in the high single-digit range for FirstService Brands in Q4.During the quarter, we announced 3 tuck-unders: Paul Davis Lexington, Paul Davis Seattle and California Closets Houston. The 2 Paul Davis deals bring to 10 the number of restoration acquisitions we have completed. We are making consistent progress in expanding our footprint, and importantly, we're making consistent progress in building out our shared services platform to support the footprint. We made several hires this past quarter in operations and HR to enhance our ability to recruit, onboard and train talent. One of our key priorities with our company-owned restoration operations is to build capacity which will drive up our performance metrics with large national accounts. We feel very good about our progress in this area. The Houston California Closets acquisition brings to 17 the number of company-owned operations for this brand. This was a key acquisition for us strategically. Houston is the fifth largest metro market, and we believe we can grow this business significantly over the next several years.Let me now pass the floor to Jeremy for a review of our financial results.

[Jeremy Alan Rakusin, Chief Financial Officer]

Thank you, Scott, and good morning, everyone.As highlighted both in our earlier press release and in Scott's prepared remarks, we reported strong third quarter financial performance. Consolidated results included revenues at $506 million, adjusted EBITDA of $59.4 million and adjusted EPS at $0.89, up 9%, 13% and 22%, respectively.Based on both the current quarter and our year-to-date financial performance through Q3, the theme you will hear from me here today is that we remain on track to hit our full year targets on all fronts from a top line and earnings perspective, free cash flow generation as well as capital allocation from our tuck-under acquisition program.To summarize our consolidated results for the 9 months year-to-date. We generated revenues of $1.43 billion, up from $1.29 billion in the prior year period, an increase of 11%, including 6% organic growth. Adjusted EBITDA was $142 million, a 19% increase over the $120 million last year driven by our top line growth as well as margin expansion to 9.9%, up 60 basis points from last year's 9.3% margin. And adjusted EPS was $1.99, up 34% versus $1.49 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 summarized in this morning's press release and are consistent with our approach and disclosures in prior periods.Turning now to our segmented highlights for the quarter.FirstService Residential generated revenues of $331.7 million, an increase of 5% year-over-year. Our EBITDA for the division increased 8% to $35.9 million. This was accompanied by EBITDA margin expansion to 10.8%, up by 20 basis points over last year's 10.6% margin. This quarter's year-over-year margin expansion is more representative of the modest improvements we have been expecting this year and going forward after the significant margin increases seen over the prior 3 years. While we will not necessarily deliver ongoing margin expansion in each and every quarter, our FirstService Residential operators are always on the lookout for opportunities to optimize their business, and we hope to continue delivering incremental increases on an annual basis.Shifting over to our FirstService Brands division. We reported revenues of $174.6 million for the third quarter, up 17% versus the prior year period. EBITDA during the quarter increased to $26.6 million, an 18% increase year-over-year, with our third quarter margin coming in at 15.2%, flat to the prior year quarter. The strong growth of our higher-margin brands division during the third quarter further accentuated our consolidated EBITDA margin improvement to 11.7%, up 30 basis points over last year.Turning now to our balance sheet.At quarter-end, our net debt was $254 million, resulting in leverage of 1.3x net debt-to-trailing 12 months EBITDA, a tick lower than the leverage at the end of Q2 and equal to the leverage ratio at year-end 2017. Our liquidity and debt capacity remained strong with close to $150 million of total undrawn availability under our credit facility and cash on hand. The strong free cash flow we have generated throughout the year has helped us maintain this conservative capital structure. Specifically in the third quarter, operating cash flow growth closely tracked earnings growth. Cash flow from operations before working capital changes was $45 million, a 21% increase year-over-year. And operating cash flow after working capital was $34 million, a 25% increase over last year's third quarter.Our capital spending during the third quarter was also in line with our annualized targets of capital deployment for both internal growth and acquisitions. We incurred just over $10 million of capital expenditures during the quarter and have now spent almost $30 million year-to-date in support of our existing businesses. We maintain our expectations for total annual maintenance CapEx for 2018 to be in the $40 million range together with modest additional growth-related investments. On the acquisition front, we deployed just over $9 million towards a handful of tuck-under acquisitions during the third quarter. Our transaction flow this year has been relatively active in a very competitive M&A environment. For the 9 months year-to-date, we have allocated a total of $53 million of capital towards 10 transactions approaching $70 million in aggregate annualized revenue. We're also confident we can close a couple of more transactions before year-end, and we continue to add to our midterm deal pipeline.So to reaffirm my comments at the outset of these remarks. The results we have delivered thus far in 2018, including the third quarter, are on track with our expectations in every respect, in particular both organic and aggregate top line growth; margin improvement driving stronger earnings growth; and execution of our tuck-under acquisition program, which positively impacts results for both this year and into next. We have strong conviction of our ability to cap off the remainder of the year in similar fashion. And during our next scheduled earnings call in early February summarizing our 2018 year-end results, we will also be in a position to provide some commentary around our outlook for 2019.And that now concludes our prepared comments. I would ask the operator to please open up the call to questions.Thank you.

[Operator]

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

[Stephen Hardy Sheldon, Analyst]

First, just wanted to make sure I heard you correctly on the fourth quarter commentary in brands. I think you said high single-digit organic revenue growth. Is that excluding the tough comp from hurricane activity? Or were you saying that you should be able to grow high single digits organically even with the tough comparison?

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

That includes the tough comparison. So we would expect to be in the high single-digit range next quarter. We will see an increase at Paul Davis in the fourth quarter from the third quarter. The point I made is that we'll be flat to down relative to the last year's fourth quarter.

[Stephen Hardy Sheldon, Analyst]

Okay. Got it. And then within Century Fire, you've talked about this, the national accounts program there. So I'm just curious how the economics of that will work. I believe all of your company-owned assets are in Georgia right now. So if you win a new national account with a national kind of service contract, how does the incremental monetization there look for you with work that you pass on to the franchise operations?

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

Well, a few things. We operate in a number of states in the Southeast of the U.S. We have 13 different operations in 7 states, so it is a -- it is very much a regional footprint, and many of the national accounts are regional in nature. We do have some national accounts and are in the process of winning others, but we use a vendor network, carefully selected vendor network, that has to meet very stringent response and operating metrics. And so we partner with vendors across the country to make sure that we deliver on our promises to the -- to our customer.

[Operator]

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

[Stephen MacLeod, Analyst]

I just wanted to circle in around a little bit on the FSB margin expectation, flat to -- flat this quarter, which is a good result in light of the fact that you've been rolling in some of the franchised operations. Just curious if you can talk a little bit about how you expect that to evolve going forward; and implicit in that, how you expect the California Closets cutting facility to impact the margin evolution. I believe you're adding a third line there. I'm just curious if you can give us some color on the timing.

[Jeremy Alan Rakusin, Chief Financial Officer]

Yes, Stephen, yes, flat for the quarter, slightly up on a year-to-date basis. We said that if -- going forward, if we can hold in on a margin basis and not suffer much dilution from mix due to company-owned acquisitions, that's a win for us. And so I wouldn't expect any near-term margin improvement in the business over the next couple of years. We don't have any cost-reduction initiatives. The California Closets one around centralized manufacturing is further out. And we're putting the pieces in place, as you just mentioned. The third line at the western manufacture center provides additional capacity as we onboard additional company-owned operations out of our roster of 17, but we don't even have the 17 fully on. And until we reach our target of 25 and have them fully onboarded at the western manufacturing center and the eastern one in Grand Rapids, we will not see that 300 basis points-plus of margin improvement that we've laid out there, yes. I think that's 2020 and beyond.

[Stephen MacLeod, Analyst]

Okay, okay. That's helpful. And then Scott, you made an interesting comment on the FirstService Residential business around focusing on larger complex communities. Can you just talk a little bit about how that dovetails with your competitive positioning and how that positions you when you are bidding on new contracts? And then I guess, secondarily to that, is there a different margin profile associated with these sort of urban high-rises, co-ops or large active adult communities?

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

I think the competition is not as significant and not as price competitive because there are fewer of our competitors that practically can provide the service that's required at some of these buildings which require specialized staff. Some of the buildings and communities, we would have 50 people on site, including engineers and lifestyle directors and event planners and many, many other specialized concierge folks. So we are able to more clearly differentiate ourselves. In addition, in the high-rise environment, we manage in the range of 2,500 high-rises. Our closest competitor is probably 1/5 of that. So our depth of knowledge and expertise is significant, and that comes through in our presentations. And I'll contrast that to a smaller HOA community, which is more, I would say, commodity like and focused on traditional management services and it's -- tends to be much more price competitive. And often, the boards are more focused and interested on price than service.

[Stephen MacLeod, Analyst]

Okay. And then would you say that these are -- tend to be higher-margin contracts? Or is it not necessarily the case?

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

Just by the nature of the competitiveness of them, they tend to be, yes, and certainly, certainly higher-revenue opportunities. And so the -- again, by -- and contrasting it with a smaller HOA community, they would certainly be higher margin than that opportunity.

[Operator]

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

[Frederic Bastien, Senior Vice President]

You deployed a fair amount of capital on acquisitions in the past few years, yet you continue to carry a very strong balance sheet. As you look ahead, how do you reconcile keeping up the strong pace of M&A growth in view of the more competitive environment for targets and -- or potentially returning more to shareholders via dividend increase?

[Jeremy Alan Rakusin, Chief Financial Officer]

Fred, we do generate strong internal cash flow, and we've been fortunate enough that we can self-fund all of our tuck-under acquisitions. They tend to be pretty small in nature, but even when we acquired Century Fire, I think our leverage went at that point from 1.5x to 2x. And we've dialed it back. So if we have our steady diet of acquisitions adding to 5% revenue growth, which is a rough target for us, I think we will still modestly delever over time, not so much from the absolute dollars on the balance sheet debt declining much but more from the growth of the EBITDA. It will come down modestly, but it's a discussion with the board every year as to where we sit, what our growth initiatives are for the upcoming year. We have increased our dividend 3 consecutive years since the spinoff at 10%. It'll be a discussion with the board again as we roll into 2019, but I don't think we're at the juncture yet where we'd be contemplating anything more significant than what we've done in the past, but ultimately, it will be a board decision.

[Frederic Bastien, Senior Vice President]

And just building on the comment you made about being pretty confident about closing a few more deals before year-end. Is that in relation to your company-owned strategy?

[Jeremy Alan Rakusin, Chief Financial Officer]

It could be on both sides of the equation. I mean we look at the pipeline, how advanced we are in discussions, where we are in a transaction process. Look, pretty well, the trend has been and will continue to be stronger acquisition growth on the brands side of the business because we've got 3 relatively aggressive growth strategies there with Paul Davis, California Closets and Century Fire. We're still very focused on adding property management company. And still it will be service providers on the residential side, but it's a more mature strategy. And I would say that it will tend to be a smaller growth opportunity on acquisitions on the residential side.

[Frederic Bastien, Senior Vice President]

Okay, last question I have. Appreciate the sort of the guidance on Q4 sort of organic growth on the FirstService Brands side, but -- and I appreciate that there's a fair amount of volatility in Paul Davis National, but as you look ahead into 2019, are you feeling pretty good about your ability to sustain sort of high double -- high single-digit to double-digit growth on the brands side?

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

Not confident in double-digit growth, but we do believe the home improvement market will continue well into '19, perhaps not at the same level it's been in '17 and '18. But we don't see any significant slowdown in any of our metrics as it relates to the home improvement market.

[Operator]

Your next question comes from the line of Michael Smith of RBC Capital Markets.

[Michael Smith, Analyst]

Just following up on a couple of questions asked earlier. Just with regard to the res business and your sort of strategy of going into -- or targeting larger, more complex communities. Could you give us some color as to what the -- new housing starts? Is that a trend within new construction, to have larger, more targeted lifestyle and complex communities? Or is anything -- has anything changed in the last few years?

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

Well, I think, certainly, active adult communities over the last 10 years have been a new development theme. And then for us, certainly, the high-rise development markets in New York City, Toronto, the major cities in California, Texas, South Florida have all been prominent for us. And that is a cyclical -- I mean we saw that 15 years ago, and then it slowed down significantly. It went away in many of those markets. And it's been relatively strong in the last 5 years, so not necessarily a new theme or a trend. It's -- but those are areas where we have focused.

[Michael Smith, Analyst]

Great. And just following up on your acquisitions. I mean you have -- there's a lot of funds out there with -- that are flushed with cash in the private equity world. I wonder if you could just give us some color on the competition, particularly for Century Fire and even their residential business. And are there any new businesses that are on horizon potentially?

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

As it relates to our tuck-under program, Michael, we're focused on smaller tuck-under businesses that expand our geographic footprint or fill-in and broaden our service line. And they tend to be small family-owned businesses $5 million in revenue, thereabouts. And so we're not seeing significant competition from private equity in that area. There are strategics that are backed by private equity that do compete with us in Century Fire, the fire business, but not really in the residential property management world. As it relates to new service lines or new businesses, we're very focused on the engines that we have currently, and so I don't see anything in our near-term future in that regard.

[Operator]

Your last question in queue at this time comes from the line of Marc Riddick of Sidoti.

[Marc Frye Riddick, Business and Consumer Services Analyst]

I wanted to just go over briefly the thoughts around some of the efforts that you've had and the discipline around pricing dynamic and maybe around renewals. I was wondering if you could give an update as to what you're seeing there and what efforts you see going forward on the pricing discipline.

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

There isn't any update of note, Marc. It -- but it does tie into some of the other questions and answers. And it really relates to communities where the board is focused more on price than perhaps the level of service. And where that is more prominent is the smaller communities where a -- smaller competitors can deliver a good and comparable service by delivering more traditional, limited management services and not a full-service offering that -- which is where we focus and are more clearly able to differentiate ourselves. So in those instances on renewal, if the board is choosing to go to bid and the price is being reduced, we're simply, in most cases, choosing not to chase that down but rather reallocating our resources to a more effective labor management opportunity.

[Marc Frye Riddick, Business and Consumer Services Analyst]

Okay. Great. And I wanted to shift gears back to the commentary around the efforts to pursue business with the larger communities, which makes a lot of sense, but I'm curious as to is there -- are there some numbers that you can sort of -- as far as getting our minds around maybe what percentage of the residential business is what you would currently consider in that bucket and maybe what you might think is a potential goal to attain in the years to come?

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

There's no -- certainly no goals or targets. I mean we've long focused on the urban high-rise market, where we have a deep, deep expertise. And that will continue. And that, today, is probably 35% of our revenue, so over time, that will increase. Not quickly, but that will increase because our differentiators are significant in that vertical. But in terms of size of the market and particular targets that we have, I don't really have numbers for you right now.

[Marc Frye Riddick, Business and Consumer Services Analyst]

Okay. And then the last thing for me, I was wondering if you can just sort of give a quick update around some of the efforts given that the labor market -- some of the efforts that you've mentioned in the past regarding being more selective on the jobs that you're pursuing on the brands side and maybe a quick thought around the progress that you're making there or as far as labor market thoughts.

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

Well, I mean, the labor market continues to be very, very tight. We have open positions at every brand. We have for a number of quarters. So we are capacity constrained, and we do have to allocate our labor effectively and in the long-term interest of the brands. So focused on our national customers and our strategic customers, first and foremost, and then as it relates to new leads and new business, we have to be strategic about that as well. But it's not an ideal place to be, and what we're really focused on is our recruiting and retention efforts. And we have been, you've heard me talk about it the last few several quarters, investing in our recruiting and retention, differentiating ourselves as an employer of choice. We have to continue to focus on those areas if we're going to continue to grow the way we have because this labor market is not going to change overnight. That is for sure.

[Operator]

And there are no further questions in queue at this time. I turn the call back to the presenters.

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

Thank you, Amy. And thank you, everyone, for dialing in. And if you have any follow-ups, please reach out. Otherwise, we will speak at the end of -- early February.Thank you.

[Operator]

Ladies and gentlemen, this concludes the Third Quarter Investors Conference Call. Thank you for your participation, and have a nice day.