FirstService Corp

TSX:FSV

Earnings Call Transcript 2022-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. Today is October 26, 2022. And I would like to turn the call over to Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

[D. Patterson, executive]

Thank you, Chris. Good morning, everyone. Thank you for joining our third quarter conference call. I'm on the line today with our CFO, Jeremy Rakusin. Let me open by saying that we're pleased with the results for the quarter that show continued strong organic growth, a tribute to our teams and the quality of our service delivery. Our service excellence culture drives customer retention, repeat business and word of mouth referral and our high single-digit organic growth for the quarter and year-to-date is a reflection of that.

Total revenues for the quarter were up 13% over the prior year with organic revenue growth at 8%, balanced about evenly between our 2 divisions, EBITDA for the quarter was $95.5 million, up modestly from 2021, reflecting a margin of 9.9% compared to 11.1% in the prior year. Jeremy will walk you through the year-over-year margin variance. At FirstService Residential, revenues were up 13% with organic growth over 8%. Organic growth was driven by solid year-over-year increases in amenity management, and again, this quarter by strong net new contract wins, leading to higher management fee and labor-related revenue. We achieved particularly robust growth in Florida and the Southeast, where we have a very strong presence. Again, this quarter, we estimate the price accounted for between 2% and 3% of the quarterly gain.

Looking to the fourth quarter at FirstService Residential, we expect to show mid- to high single-digit revenue growth, all organic. Moving on to FirstService Brands. Revenues for the quarter were also up by 13%, approximately half of which was organic. Our home improvement brands, led by California Closets were again very strong this quarter with year-over-year growth of near 30%. The growth figure reflects higher capacity and production relative to the third quarter of 2021 that was weakened by supply chain and COVID-related disruption. Sequentially, revenues were up modestly relative to Q2 as we continue to have some success in adding production capacity despite a tough labor market.

We're very pleased with the results from our home improvement brands that exceeded expectations for the quarter. The teams have done a great job of capitalizing on strong demand in a tough operating environment. Looking forward to the fourth quarter, we expect to again show some sequential growth from Q3 and year-over-year increases of about 15% against a strong fourth quarter in 2021.

Let me now turn to Century Fire before we talk restoration. Century had another strong quarter, growing by over 20%, half organic. Growth was again buoyed by a solid commercial construction market and strong momentum with our national account service and repair program. Backlogs and bid activity remained very strong, and we expect similar year-over-year growth in Q4. Our restoration brands, Paul Davison, FirstOnSite generated revenues that were approximately flat with the prior year and down mid-single digit organically. We did not book any revenues during the quarter from named storms or area-wide events and are pleased that we were able to match prior year revenues that included $30 million primarily from Hurricane Ida.

Organic growth for the quarter, excluding storm revenues, was about 10%. On September 24, Hurricane Fiona swept through Atlanta Canada causing damage primarily in Nova Scotia, New Brunswick and Prince onward Island. Both Paul Davis and FirstOnSite responded to the event and are working in the area, but we did not book any revenue in September. Revenue generated from Fiona will fall into our fourth quarter and perhaps into next year. A few days later on the 28th of September, Hurricane Ian made landfall in Southwest Florida and caused significant damage in the Fort Myers area, and continued up through Orlando and the Northeast Coast of Florida, went offshore and then made landfall again in South Carolina. This was a big category 4 event that caused catastrophic damage primarily from flooding related to an unprecedented storm surge. We have thousands of associates that live and work in the area of the storm and thankfully, they are all safe, although a number of them unfortunately lost their homes or suffered significant damage.

We are helping these employees that have been impacted through the FirstService Relief Fund that was set up 5 years ago to provide aid in a situation just like this. Both FirstService corporately and our associates contribute to the fund, and I'm proud to report that in the last 4 weeks, we have provided over 250 grants to team members that experienced financial hardship related to the storm. The storm not only impacted our associates but also many of the communities that we manage in the area through FirstService Residential. Our teams are working closely with our boards and residents to document damage for insurance purposes and to facilitate the cleanup mitigation and restoration process.

Both Paul Davis and FirstOnSite have been on standby and are working closely with FirstService Residential throughout Florida and South Carolina to help our managed communities during this difficult time. The collaboration has been very strong. depart and apart from first service managed communities, both Paul Davis and First on site are engaged and working on hundreds of projects in the affected area. It is still too early to quantify what this will mean to our restoration businesses in terms of revenue in the coming quarters. Many of the jobs we are tentatively engaged on maybe come tear down and rebuilds rather than mitigation and restoration jobs.

In addition, we're working with many clients to confirm insurance coverage before restoration commences and the outcome could affect the amount and type of work performed. The situation continues to evolve. At this point, our best estimate is that restoration will show about 20% revenue growth in Q4 relative to the prior year. This is assuming we generate $70 million from hurricanes Ian and Fiona with the bulk from South Florida work relating to Hurricane Ian. In the fourth quarter of last year, we generated $40 million from Hurricane Ida. Work related to Ian and Fiona will definitely roll into 2023, but we are not in a position to quantify the level of backlog that will carry forward at this point. We'll obviously provide an update on our year-end call. Staying on restoration.

Earlier this week, we were excited to announce the addition of 3 companies to our restoration platforms. The acquisitions enhance their geographic footprint and service capability. First on site acquired watermark restoration bolstering our presence in the U.S. Southeast, particularly in Alabama and North Carolina and adding several significant customer relationships. In Canada, FirstOnSite acquired the assets of Contra Global Solutions, a reconstruction company that enhances our full-service restoration offering to commercial clients in the Toronto metro market. And finally, we acquired a majority stake in our Paul Davis franchise serving Nebraska and Southern Missouri. It's one of the largest and most successful Paul Davis franchises in the network, and we're excited to partner with Roger Fredstrom and Jeff Theobald to drive further growth in the Midwest U.S. On that, let me now hand off to Jeremy to walk through the results in more detail.

[Jeremy Rakusin, executive]

Thank you, Scott. Good morning, everyone. Our third quarter financial results came in largely matching our internal expectations and mirrored the quarterly performances delivered during the first half of this year. The overriding themes also remained similar to prior quarters, with strong across-the-board top line organic growth driving our performance, partially offset by the same factors contributing to margin dilution.

I will elaborate on these drivers momentarily, but let me first summarize our consolidated results. For the current third quarter, FirstService recorded total revenues of $960 million, up 13%, and adjusted EBITDA came in at $95.5 million, up 1% relative to the prior year period. Our adjusted EPS was $1.17, down from a reported $1.50 from Q3 last year, which included a $0.21 per share gain on sale from a noncore business. So earnings per share down modestly year-over-year against a normalized $1.29 after adjusting for this prior year gain. Highlighting our consolidated performance for the 9 months year-to-date, we have delivered revenues of $2.73 billion, up from $2.39 billion in the prior year period, an increase of 14%, which includes 8% organic growth.

Adjusted EBITDA stood at $249.2 million with our overall EBITDA margin at 9.1% compared to $243.8 million and a 10.2% margin for the prior year period. And lastly, our adjusted EPS year-to-date is $3.02, down from $3.36 reported for the same period last year. Our adjustments to operating earnings and GAAP EPS in providing adjusted EBITDA and adjusted EPS, respectively, are disclosed in this morning's earnings release and are consistent with our approach in prior periods.

I'll now dive further into our third quarter segmented results for our 2 divisions. At FirstService Residential, we generated revenues of $478.6 million, a 13% increase over Q3 2021. This strong top line performance drove EBITDA of $49.6 million, a 10% increase year-over-year. We incrementally continue to close our year-over-year margin comparison with the current quarter EBITDA margin yielding 10.4%, 30 basis points lower than the 10.7% in last year's Q3. The margin was influenced by a higher mix of the labor-based services that Scott referenced earlier as driving our growth compared to higher-margin ancillaries. Higher-margin transfers and disclosures revenue, in particular, saw a greater-than-expected year-over-year decline due to reduced home resale activity compared to the robust levels we have called out in previous quarters.

We are pleased with our progress in clawing back from a 100 basis point margin gap with improving comparison sequentially over the past 4 quarters. Now on to FirstService Brands. The division generated revenues of $481.9 million during the current third quarter, up 13% versus the prior year period. Our brands EBITDA was $48.8 million with a 10.1% margin, down versus $53 million and a 12.4% margin in last year's third quarter. Our Brands margin decline during Q3 was due to the combination of continued growth-related investments in our restoration operations together with the absence of revenue from any notable weather-driven activity versus last year, which benefited from the Hurricane Ida and Texas freeze events during the comparable period. We explained the same margin dilution dynamic in our most recent second quarter call as well, and on a sequential basis compared to Q2, our brands margin improved by 80 basis points, up from 9.3%.

Now on to our consolidated cash flow, where before working capital, we generated $72 million of operating cash flow in line with the prior year. Working capital requirements during the quarter absorbed all of this cash flow for a couple of reasons. We had timing-related tax and payroll payments that were both adverse to our cash flow in the current quarter and compared unfavorably versus the prior year period. In addition, with Hurricanes Fiona and Ian landing in the latter half of September, our restoration operations incurred meaningful upfront mobilization and preparation costs in advance of those events without realizing any corresponding revenue during the quarter.

As Scott mentioned earlier, our teams are still in the early stages of the damage assessment and remediation planning with our clients and preliminary indications are that we will have a lengthy backlog tail into 2023. Although timing is unclear at this juncture, we will ultimately see cash conversion of the working capital investments relating to these weather events over future quarters. Beyond working capital, the other leg of investments supporting organic growth is our capital expenditures, CAPEX during the quarter came in at $19 million, resulting in $55 million of spending year-to-date. We are pacing within our previously set annual target of $85 million and may come in a little lower than that level for the full year. In terms of our tuck-under acquisition program, we have remained steadfastly disciplined with what we are willing to pay for potential targets in the face of aggressive competitive bidders, and this has tempered our activity during 2022.

We strive to be prudent and opportunistic with all of our investment dollars, whether deployed for organic growth purposes or towards acquisitions to meet our return on investment expectations. We did see some modest acquisition activity during the quarter. And as Scott touched on, we also closed a couple of additional restoration transactions post third quarter. These tuck-unders will augment our growth heading into 2023. Our deal pipeline remains active, and we expect to convert on additional opportunities in the coming months.

Our balance sheet at quarter end included net debt of $556 million, resulting in our leverage coming in at 1.6x net debt to trailing 12 months EBITDA, up slightly from 1.5x in the previous second quarter. This leverage threshold is very much in line of where our capital structure settled over the past several years and remains conservative and well within our comfort level.

Our liquidity and debt capacity also remained strong with approximately $550 million of total cash on hand and undrawn availability under our credit facility. At the end of the third quarter, we also announced new 3-year senior note facility arrangements with our 2 long-standing lenders, Prudential and New York Life, simultaneously with the issuance of an additional $60 million of 10-year notes with a 4.53% coupon from New York Life. The financing improved the current balance of our debt mix to a healthy level of 1/3 fixed and 2/3 floating. The facilities also enhanced our financial flexibility to incrementally tap into multiple tranches of long-term notes in varying amounts over the next 3 years. With the uncertain and volatile interest rate environment, flexibility in managing our financing costs and diversifying our debt maturities is a key element in maintaining our strong balance sheet.

In terms of our outlook for closing out 2022, our consolidated revenues for the fourth quarter will see low double-digit to mid-teens percentage growth over Q4 2021, including the assumption of realizing roughly $70 million of hurricane work, as Scott mentioned. We expect that Q4 consolidated EBITDA growth should roughly match the top line performance with consolidated margins in line or possibly a little better than the prior year quarter and somewhat dependent on the type of restoration work performed during the period. After going through budget and strategic planning review processes with each of our operations in the coming weeks, we will provide a 2023 outlook during our 2022 year-end earnings call scheduled for early February. That concludes our prepared comments. Operator, can you now open up the call to questions. Thank you.

[Operator]

[Operator Instructions] Our first question will come from Michael Doumet of Scotiabank.

[Michael Doumet, analyst]

The first question I had was, is really on the residential piece here. Just trying to figure out the margin story because it feels to me like those 2 major drivers here, and I'd like to pull those apart, just for the sake of better understanding where margins can land in Q4 and obviously in 2023 for that segment. So on the one hand, it sounds like you're raising price and you're having success there driving better labor recoveries. On the other hand, you're calling out unfavorable mix, and I'm not sure what the comps look like for the next coming quarters. So just given those puts and takes, do you think the net trend is still positive for that segment to Q4 into 2023?

[Jeremy Rakusin, executive]

Michael, yes, I'll take that. continued improvement, and we've done it for 4 quarters, and we continue to expect to close the margin gap. Best guess is that we will, in Q4, match year-over-year margin performance. The perhaps a little bit of the shortfall in Q3 and accounting for that as well in Q4 in my in what I just said, would be a significant falloff in transfers and disclosures revenue, home resale activity at the lowest level for this quarter in the last 10 years.

So it's actually reversed from above average levels over the couple of years during COVID to well below average levels in this quarter. And so that's a mix dynamic. And as for the other component in terms of covering up wage inflation, it's a combination of pricing and the efficiencies, and we believe that dynamic at least for now, is largely covered off. It was more of a mix phenomenon.

[Michael Doumet, analyst]

Got it. Helpful, thank you and then on restoration, how should we think about the margin improvement there and how it plays out in the medium term, again, putting aside the variability from the storm activity. I guess the way I'm thinking about it, does the margin normalization there happen as you complete the investments? Or is it really just a function of higher revenues, higher throughput and scale that will absorb the higher OpEx investments?

[Jeremy Rakusin, executive]

In the absence of any meaningful weather events, this is going to play out over a longer period than the next couple of quarters through 2023 at a minimum, we're going to be operating below kind of more like mid-single-digit margins like we have at Q2 and Q3 without any weather. The weather events give us operating leverage to perform at a higher level brings an incremental EBITDA at a higher margin level. When we threw the investments, we expect to reap, but that's a kind of multiyear exercise, and I spoke at Q2 that it's analogous to a multiyear exercise that we went through with FirstService Residential back 8 years ago.

[Operator]

[Operator Instructions] our next question will come from Stephen MacLeod of BMO Capital.

[Stephen MacLeod, analyst]

I just wanted to get some color on home improvement. It was strong Q2, again strong Q3. And just curious if you can give a little bit of color around what you're seeing in terms of job leads heading into Q4. And then maybe more importantly, heading into next year, considering the weaker macro backdrop that we're seeing.

[D. Patterson, executive]

Sure, Stephen. I mean, I think I mentioned last quarter that leads and bookings have come off in the last several months, but they do still remain at a healthy level. And we have clear visibility through year-end. And as I mentioned in my prepared comments, we expect to show a 15% revenue growth over Q4 that was last year that was quite strong. At this point, we believe we will enter 2023 in a similar healthy position with a solid backlog. We'll certainly provide more color and visibility on our year-end call. It's our intention that we will certainly grow in 2023.

It's not likely to be at the same pace as we're seeing this year. We're knocking out some big numbers in home services, but certainly, we will grow next year. And even with the backdrop of this uncertain environment, I mean our perspective in these markets is that they're huge, and our share is modest to small even in a downturn, the work will be there, and we need to go and get it.

[Stephen MacLeod, analyst]

Right. Okay. That's great. And then just turning to acquisitions. Jeremy, you mentioned the continue to be disciplined, but you did complete a couple of deals recently, a few deals. Wondering if you can just give some color as to where you're seeing the pipeline being most robust and where you'd like to execute if the prices are right.

[D. Patterson, executive]

Well, really nothing's changed. As Jeremy said, the pipeline is pretty good. It's solid. We've Certainly, in terms of the number of deals we closed, was it slowed in the first 6 months, but you saw our announcement earlier. As Jeremy said, we expect to close a few more this year. We think on balance, this year will end up being a decent year on the acquisition front. It's balanced. We're looking across all our platforms and engaged across all the platforms. Restoration continues to be healthy as it has been for the last couple of years. I would expect the next year to resemble what we've done in the last few years. I don't know if I answered your question completely, but...

[Stephen MacLeod, analyst]

Yes. No, that's great, Scott. I mean it sounds like things are tilted towards restoration in terms of the end markets and almost there's other areas that you're interested in to?

[D. Patterson, executive]

It is, which it has been for the last few years, but we are engaged across all the platforms.

[Operator]

[Operator Instructions] And our next question will come from Faiza Alwy of Deutsche Bank.

[Faiza Alwy, analyst]

I wanted to get your perspective on the labor market. And it sounds like things have eased a little bit from where we were just a few months ago, but I wanted to get your perspective on what you're seeing in the marketplace now? And sort of if you have any prognosis of where we might go as we look ahead to 2023?

[D. Patterson, executive]

You said it's eased a little bit. I think that's right on. It has eased, but it's been very incremental for us. Labor availability remains a big, big issue. It's, if not the top priority very close at every one of our brands and remains most pronounced at the entry level. where we still have too many open positions. So everybody is on it. There's been some improvement through 2022, but it's been slow. And I think it's going to remain tough for the foreseeable future.

[Faiza Alwy, analyst]

Okay. Okay. That's helpful. And I guess, I'm curious, you've talked about a little bit of pricing. Are you, at this point, like have you recovered sort of all of the cost increases that you've been seeing? So all of the inflation that you've been seeing? Like are you sort of on a one-to-one basis at this point? Or is there still more of a recovery to go in terms of pricing and recovery of costs as we look ahead to 2023?

[D. Patterson, executive]

Yes, I'll start with that, and then Jeremy, maybe you can fill in because there is a difference between our 2 divisions. At FirstService Residential, it is an ongoing exercise. The price increase baked into our organic growth is sort of between 2% and 3%. Certainly, our costs are up by more than that. So we have not recovered it at FirstService Residential. We're clawing our way back through price increases, but also through efficiency. And Jeremy you can fill that out in more detail. And then we're having much more success on the brand side in terms of passing through the prices the cost increases. Jeremy, anything you want to.

[Jeremy Rakusin, executive]

Yes. I think Scott characterized it correctly. On the brand side, it's a lot easier to pass forward not just in terms of having more pricing power but they're job based, so you don't have to wait for annual contract renewals typically a quarterly lag. But absent the investments in first on-site, our other businesses, home services and first and Century Fire have performed very well on the margin side, meaning that pricing is covering off all inflationary pressures, labor and other material inputs. And on the resi side, again, the outlook to close the gap and you have flattish year-over-year margins by Q4. We're using multiple levers. As Scott said, the continuing efforts on pricing, but we need the efficiency angle as well to cover off the fact that costs are a little higher than pricing in that side of the business.

[Operator]

[Operator Instructions] Our next question will come from Daryl Young of TD Securities.

[Daryl Young, analyst]

My first question is around Century Fire. And 50% of the business on the monitoring side would be highly resilient. On the other 50%, could you just give us a little bit of color on the installs, what end markets would be the key drivers there? Is it multifamily? Or is it more commercial?

[D. Patterson, executive]

It's commercial, and we include multifamily in that definition all types of rental buildings, 3-story walk-ups, high-rise towers. It also includes distribution warehouses, which remains strong, data centers. And it really cuts across office and retail as well, Daryl. It's very robust right now for us, sprinkler installation and alarm installation.

[Daryl Young, analyst]

Okay. Great. And then the second question is also on Century Fire. Just looking out a few years, I mean, your growth rates have been exceptional at Century Fire. Is there an investment cycle similar to what's happening in restoration that will need to happen at Century Fire as you integrate that platform? Or are you still a few years away from sort of going through that similar exercise?

[D. Patterson, executive]

No, we're, it's not as significant an exercise because the growth has been as strong as it's been. It's been paced over, I guess 7 years now. And so we've been at it, and we do have a platform that we are integrating our tuck-unders into, and we've been investing in the last several years, but just more moderately relative to the significant expenditure we're seeing at first on site.

[Daryl Young, analyst]

Okay. Great. And actually, maybe just one last one. With respect to FirstService Residential, I think the answer is no because you didn't call it out, but is there anything we should be aware of in Florida related to the hurricane activity that could be an issue for service residential?

[D. Patterson, executive]

We don't think so. I mean, it's very stressful on our teams this whole event because we do manage so many properties that were in the area of the storm. So our managers, our teams are working extremely hard. But these communities still need to be managed and through this event. And so there really won't be we don't see any impact one way or the other.

[Operator]

[Operator Instructions] Our next question will come from Stephen Sheldon of William Blair.

[Stephen Sheldon, analyst]

Hey thanks, Just one quick one for me. In brands, how concerned are you about weakening consumer sentiment starting to weigh more on demand in the home improvement businesses? It doesn't sound like it's having any notable impact yet, but do you see that as being much of a risk into 2023? Or does the demographic of the customer base that you typically sort of provide some support?

[D. Patterson, executive]

No, I think we're, we see it as a potential risk, Stephen, definitely. But as I said, earlier, these are huge markets, and we have small share and we're the largest in all these markets. So it's our belief that we can grow in any environment. The work is out there. And we saw that in particularly with CertaPro Painters and Floor Coverings International in the great financial crisis, we grew right through it. CalClosets was hit a little harder, but we think we're in a better position now, and we think that the likely recessionary environment will be different. So we're -- we feel good about '23.

[Operator]

[Operator Instructions] Our next question will come from Frederic Bastien of Raymond James.

[Frederic Bastien, analyst]

During the previous earnings call, you expressed confidence in closing some tuck-in acquisitions in fairly short order. And obviously, we saw that earlier this week. How are you feeling about the pipeline as you exit this year and start looking at next year?

[D. Patterson, executive]

Well, it's I think we have opportunities in our pipeline that will we won't close until 2023. So at this point, I feel optimistic. And I think our expectation is that we'll see in the coming year, we'll see more opportunities. We have liquidity and are in a position to move quickly, whereas relative to some of our competitors that we've been facing in the last couple of years. They may be more reticent in the interest rate environment that we're going to see that we're seeing today and we will see in '23. So I think we're optimistic.

[Frederic Bastien, analyst]

Great. And is the focus still predominantly on building your restoration franchise versus and being remaining opportunistic in other service lines?

[D. Patterson, executive]

I would say yes, but we do have opportunities really across the board right now. And so the focus on restoration will be coming off as we continue to fill out our footprint. We're getting to a point we're not there yet, but we'll get to that point where we'll have primarily an organic growth engine, and that's where a lot of this investment is focused that Jeremy has been describing the last couple of quarters.

[Frederic Bastien, analyst]

Okay. Another question is on FirstService Residential, 8% organic growth, which if you exclude the 3% you got from gaining is right smack with in line with your long-term guidance. How do we think about that going forward? I mean is it reasonable to assume that the price increases you experienced in the quarter could be kind of repeated in the next 2, 3 quarters? Or I mean do you expect things to kind of settle back to this long-term average target that you have?

[D. Patterson, executive]

No. I think, I mean, the pricing we've always had some level of price increases though even though it was modest. So our price increase level is up about 1% or 1.5%, and we expect to continue to see that in the next few quarters. We did get a boost this quarter from amenity management, primarily pool maintenance and repair and work that had been deferred through COVID. We wouldn't expect to see the same kind of boost in the fourth quarter because it's a nonseasonal quarter in that business. But we think we'll settle back into the mid-single-digit level going forward.

[Operator]

[Operator Instructions] And now seeing no further questions in the queue, I would now like to turn the conference back to Mr. Scott Patterson for closing remarks.

[D. Patterson, executive]

Thanks, Christian, and thank you for joining, everyone. We look forward to reporting on our year-end in early February. Have a great rest of your day.

[Operator]

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a pleasant day.