FirstService Corp

TSX:FSV

Earnings Call Transcript 2017-Q4

[Operator]

Welcome to the fourth 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 different 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 Wednesday, February 7, 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, operator, and welcome, ladies and gentlemen, to our fourth quarter and year-end conference call. Thank you for dialing in. I'm here today with Jeremy Rakusin, our CFO. I will open with a summary of our quarterly results and speak to some of our highlights. And then, Jeremy, will walk you through the quarterly results in a little more detail, and also, the full year financial results. Let me start by saying that we are very pleased with the strong fourth quarter results we reported this morning, results that capped off another very successful year for us at FirstService Corporation. Revenues came in at $438 million, up 15% over the prior year quarter, with half of the growth generated organically and the balance from acquisition. This equal balance between organic growth and acquisition growth is something that we strive for, and we hit it on the button this past quarter. EBITDA grew 32% over the prior year quarter with a margin expanding 120 basis points to 9.2%. Earnings per share were up 24%. So 15% top line growth and 32% growth at the EBITDA line. We finished the year very strongly. Both of our divisions had strong quarters and great years. At FirstService Residential, revenues grew 6% in total for the quarter, 3% organically, generally in line with the last several quarters. Growth was broad based geographically and by service line as ancillary services in the aggregate grew approximately in line with management fee revenue. EBITDA margins were significantly improved at FirstService Residential, marking the 11th consecutive quarter with year-over-year margin improvement in this division. Jeremy will provide more detail in a few minutes.Looking at FirstService Brands. Revenues were up 38% versus the prior year, comprised of a very strong organic growth rate of 16% and the balance 22% from the 5 tuck-under acquisitions completed over the past year related to our company-owned acquisition strategies at Paul Davis and California Closets. The organic growth of 16% at brands was outsized relative to previous quarters this year, and largely driven by incremental work performed by Paul Davis National in Texas and Florida relating to Hurricanes Harvey and Irma.As a reminder, Paul Davis National is our large loss operation within Paul Davis restoration. It is company-owned, and has very specific expertise and equipment necessary to service large scale disasters. It is also positioned with our national customers as the point relationship during natural disasters to coordinate effort amongst our company-owned and franchised operations. The incremental revenues from the hurricanes came primarily through direct work by Paul Davis National, but also through increased royalty revenue as our franchises in affected areas booked incremental work. Normalizing for these revenues, drops the organic growth rate for the division closer to 10% for the quarter and more in line with the full year trend. Outside of Paul Davis, the strong organic growth at Brands was led by our California Closet company-owned operations and Century Fire. Again, our California Closet company-owned operations outpaced the franchise system, continuing the trend we are seeing for the last several quarters.As I have mentioned in prior calls, we have assertively invested in building capacity at our company-owned operations relative to the franchise system, and we are seeing a return on this investment in the form of increased organic growth.At Century Fire, we saw double-digit organic growth in the fourth quarter. We finished the year very strongly at Century and we continue to be quite bullish about this business and our opportunity at fire protection. Looking forward, we feel very good about our operational momentum, the strength of our markets and our acquisition pipeline, all of which bodes well for another strong year in 2018. I want to reiterate that we are very pleased with how our year turned out. And I want to take this opportunity to thank our operating partners, our employees and the owners and employees of our franchises for their commitment and hard work in helping us complete a very successful 2017. And on that note, I will transfer over to Jeremy.

[Jeremy Alan Rakusin, Chief Financial Officer]

Thank you, Scott, and good morning, everyone. As highlighted in our press release this morning, we finished 2017 strongly, with our fourth quarter performance tracking close to our full year financial results, mid-teens percent top line growth and mid-20% bottom line growth over both periods. Specifically for the fourth quarter, as Scott noted, we reported revenues at $438 million, up 15% versus the prior year quarter. Adjusted EBITDA at $40.5 million, up 32%. And adjusted EPS at $0.51, up 24% versus Q4 2016.For the full year 2017, annual revenues were $1.71 billion, a 15% increase over the $1.48 billion for 2016, and supported by a solid 6% organic growth. Adjusted EBITDA was $162 million, up 24% over the $130.3 million last year, with our margin expanding by 70 basis points to 9.5%, up from 8.8%. And adjusted EPS was $2.03, up 25% versus the $1.62 per share reported for 2016. As disclosed in prior conference calls as well as this morning's press release, certain adjustments have been made from GAAP operating earnings and per share earnings to arrive at our adjusted EBITDA and EPS results, each of which are consistent in approaching disclosures adapted in prior periods. Now let's shift focus to our 2 reporting divisions: FirstService Residential and FirstService Brands. Leading off with FirstService Residential, revenues were $291 million for the fourth quarter, a 6% increase versus the prior-year period. Our EBITDA increased 36% to $23.4 million, driven by 170 basis points of margin expansion quarter-over-quarter. The margin increase largely reflects a continuation of our often repeated theme over the past 2.5 years, cost reductions through centralization or regionalization of local operations and through improved, streamlined and automated processes.As with the case in Q3, the margin expansion was further magnified by superior utilization of our teams of people and resources to better serve our clients and meet our return objectives. For the full year, FirstService Residential grew at the same 6% pace on the top line, with 4% coming from organic growth. The division also reported significantly improved profitability for the year with an 8.5% margin, 90 basis points higher than the 7.6% level in our 2016 full year results, a real testament to strides made by the management team and operators in driving sustainable efficiencies across the business.Turning to our FirstService Brands division. For the fourth quarter, we generated revenues of $147 million, up 38% versus the prior-year period. And EBITDA grew by 26% to $20.2 million. For the full year, the division delivered 44% total revenue growth, including a 12% increase on an organic basis, underpinned by consistent double-digit growth in all 4 quarters of 2017. Scott called out the strong performance within our company-owned operations at Paul Davis, California Closets and Century Fire, which amplified our organic growth. And then, we also benefited in both Q4 and throughout the year from acquisitions within each of these service lines, which provided the added boost to the top line.We have thus seen a pronounced shift within our brands division towards greater contribution from our company-owned operations, which typically deliver anywhere from 8% to 10% EBITDA margins relative to our higher-margin franchise businesses. This mix change resulted in dilution to our overall margin for FirstService Brands, with very similar impacts in both the quarter and on an annual basis. Specifically, 13.7% in Q4, down from 15.1% in the prior year quarter, and 14% for the 2017 fiscal year versus 15.2% in 2016. Shifting back to our consolidated financial results. FirstService ended the year with a strong $116 million in operating cash flow, including just under $40 million in the fourth quarter, roughly double the $20 million in Q4 2016. Capital expenditures for 2017 tallied $36 million, within the guidance range previously provided during the year. On the acquisition front, we deployed a healthy dose of spending in 2017, almost $40 million on 9 tuck-unders, including 5 within FirstService Residential and 4 from our Paul Davis and California Closets service lines within FirstService Brands. These businesses collectively added roughly $80 million to the top line on an annualized basis, and fit with our strategy of gaining stronger footholds in key large markets and broadening our service offering. With respect to our balance sheet, year-end net debt was $212 million, resulting in leverage of 1.3x net debt to 2017 adjusted EBITDA, down from the 1.5x level at both our most recent third quarter and 2016 year-end. Our robust cash flow in 2017 was more than sufficient to finance both the $40 million of acquisitions spending and $34 million in total capital returns to shareholders at being $17 million a piece of annual dividends in normal course share buybacks and yet further reduced our balance sheet leverage from the prior year. After year-end, in mid-January, we further bolstered balance sheet with an increase and extension of our 5-year revolving credit facility to $250 million, up from $200 million. With this expanded debt capacity, our current liquidity in terms of the remaining available drawn on revolver and cash on hand is in excess of $185 million.Yesterday, we also announced that our Board had approved a 10% increase in our dividend. The third consecutive annual dividend hike of 10% plus since our inception as a new public company after the mid-2015 spinoff. The new dividend will distribute $0.54 per share on an annualized basis in U.S. dollars, up from the prior $0.49. Our balance sheet has never been stronger, providing us with ample capacity to fund the $20 million in new annual dividends, while at the same time, providing us with lots of flexibility to pursue our growth opportunities.Lastly, let me wrap up with some high-level comments regarding our outlook for 2018. Consistent with the picture we painted over the past 1.5 years or so, we expect consolidated organic revenue growth to be in the mid-single digits. Our objective is then to compete several tuck-under acquisitions during this year to drive towards a total top line growth of 10%-plus, consistent with our long-term goal. On the margin front, we will strive to very modestly increase our consolidated EBITDA margin over 2017. With our FirstService Residential division expected to extract some further margin improvement, albeit significantly smaller than the last couple of years. However, this margin expansion could very well be tempered by potential moderating of our FirstService Brands margin due to the increasing mix of our faster growing, lower margin company-owned operations.On the net earnings line, we will benefit from leverage in 2018 versus 2017 due to the impact of recent U.S. tax reform legislation. We estimate a lower effective tax rate in the range of 25%, down from the low to mid-30% range in the last couple of years. Finally, with respect to capital expenditures for the year, we expect to invest approximately $40 million in our existing operations, a modest increase from last year as we further deploy capital towards growth of our Paul Davis and California Closets company-owned platforms and our Century Fire business. This concludes our prepared comments. Operator, could I please ask you to open up the call to questions. Thank you very much.

[Operator]

[Operator Instructions] And the first question comes from Stephen MacLeod from BMO Capital.

[Stephen MacLeod, Analyst]

I just wanted to just drill down a little bit on the margin outlook, both on the FirstService Residential side and the Brand side, and just sort of how that rolls up to the top to the consolidated level? And do you still sort of expect to progress towards a 10% target on a consolidated basis?

[Jeremy Alan Rakusin, Chief Financial Officer]

Stephen, yes. So let's take each of them. FirstService Residential finished at 8.5%. We believe we've got further efficiencies, primarily around client accounting. Again, this is a multiyear journey. We go market by market. We've got different modules involved in extracting some of those local costs and streamlining the operations around accounts payable, accounts receivable and so on. So we believe we've got at least a couple more years of opportunity to extract margin. They will be significantly smaller bites than the margin improvements we've had over the last couple of years. And then, on FirstService Brands, it's really a function of how strong the company-owned operations, Paul Davis, California Closets and Century Fire grow, both organically, which we saw a very strong growth in 2017 as well as through additional acquisition and how that -- the dynamics of those 3 businesses drive mix in the overall FirstService Brands division. So if those continue to grow strongly, there could be, as I said in my prepared comments, potential margin dilution from 2017 to 2018 at FirstService Brands. That would be a good story, notwithstanding potential margin dilution because it would mean we're driving greater revenue and cash flow growth at stronger levels with the tailwinds of those operations. So we'll take it if it happens. We're investing those business at good returns on capital and we think it's good for managing the overall growth of FirstService. In terms of whether we can hit 10% on a consolidated basis, it really depends on the mix of brands. It's a possibility, we don't have a time horizon. It really depends on, again, that mix dynamic at FirstService Brands and how the margins perform in that business over the next couple of years.

[Stephen MacLeod, Analyst]

Right. Okay. Okay. And then, just on the FSR side. You talked about a couple more years of expansion. Does a lot of that still come from labor cost management and just operational efficiencies that you've been driving over the last few years? I mean, is that what kind of drives that incremental margin growth, I know, albeit at a smaller rate, but are those sort of the key drivers?

[Jeremy Alan Rakusin, Chief Financial Officer]

Correct. Yes. And again, a lot of the back office functions, the low-hanging fruit, we talked about completing a lot of that in 2015, '16 and a part of '17. And really, client accounting is the biggest remaining piece, and it's hard to get it done all in one fell swoop. So we go, again, market-by-market. There's different pieces to it. The management team does a great job of finding opportunities to optimize after things are implemented. And it still revolves around that area.

[Stephen MacLeod, Analyst]

Right. Okay. Okay. That's great. And then, just finally, just talking about the top line outlook on the FirstService Residential side. The housing market in the U.S. still, obviously, quite strong. And I'm just wondering, are you seeing still kind of that 20% to 25% of your new growth coming from new development? Or is that number changed at all over the last couple of quarters? And I mean, I guess, maybe looking forward as well?

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

Yes, it's been pretty consistent, Stephen. New development is still reasonably strong, particularly in New York City, California and Texas. It is slowing in Florida and Toronto and in some other markets. But we do expect to continue to benefit from that -- in that 25%-plus range relative to our overall organic growth.

[Operator]

Next, we have a question from Michael Smith from RBC Capital.

[Michael Smith, Analyst]

I just wanted to -- one more question -- follow-up question on the margins. So in the Brands division, if there was no change in mix, what would -- how would the margins trend?

[Jeremy Alan Rakusin, Chief Financial Officer]

Likely up. We get a little bit of operating leverage within the franchise businesses. And the California Closets business, the company-owned operations, we've seen margin improvement at the -- at each company-owned location that we owned for at least a year in terms of margin improvement as we take those 8% to 10% margin performance up. So aside from mix, the margins would be modestly higher.

[Michael Smith, Analyst]

Okay. And just switching gears to your tax rates. So I think your overall tax rate is going to be sort of about 25%, is what you said in your prepared remarks. Just wondering how is that going trend in the future? Is there any changes or...

[Jeremy Alan Rakusin, Chief Financial Officer]

No. 25% would be the new overall consolidated tax rate under U.S. tax reform. Both regions, the U.S. and Canada, have been in around 26% and we've got some other structures that allows to nudge it down a bit. It's 25% to the extent there's any other one-off items that happen from year-to-year. They could be up or down. We saw, as an example, in 2017, the U.S. GAAP change around stock-based comp, tax treatment took our tax -- our reported tax rate lower. That could happen again in '18 and '19. But I think 25% is a good long-term rate to be using as fundamentals of the business.

[Michael Smith, Analyst]

Okay. And just in terms of switching to the residential business, your efforts for driving margin have paid off nicely. It looks there's a little bit more to go. And part of that was losing a little bit of -- your renewal rate went down a little bit as part of that exercise, I guess, from the mid-90s, 95, 96 to sort of 93-ish. Do you -- any -- what are your -- how are you thinking about your renewal rates going in the future?

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

Well, we're working -- certainly, working to get them higher, but at the same time, very disciplined around renewals and the effect of allocation of our labor. So we talked about this last few quarters, ensuring that we're earning the appropriate margin and getting price increases on renewal. We're experiencing some wage pressure. And so if in the face of lower cost competition, we are forced to allocate that labor differently than we're looking to do that. So that's, I would call it -- I called it in the past, healthy retention. And if healthy retention is 93, 94, then we are happy to stay there. If we can drive it up to 95, 96, we are looking to do that.

[Michael Smith, Analyst]

Okay. Great. And then, just last question, just on Century Fire. Wonder if you could just give us some color on the potential for external growth or acquisition growth in that segment?

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

We have opportunities in our pipeline. It doesn't mean they're going to happen, but it's certainly a strategic focus for us to expand within the southeast of the U.S., primarily. And so we're looking in Florida, the Carolinas, in particular, and to add services in our existing operations. It is a more competitive environment than we see in some of our other markets. There are private equity. There are large operators that compete in this market. But we feel confident, and certainly, we're working hard with that management team to look at opportunities.

[Michael Smith, Analyst]

Okay. Actually, just one more. Any new businesses like pest control, that you're considering? Or anything else?

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

Not currently. Always open-minded. Always looking, but there's nothing that we're looking at right now.

[Operator]

Next, we have a question from Stephen Sheldon from William Blair.

[Stephen Hardy Sheldon, Analyst]

I guess, first, I wanted to ask about the organic growth within brands. And I wanted to know if you view kind of the hurricane-related activity at Paul Davis as something that will mostly just impact the fourth quarter? Or if it's something that has legs that will likely continue to some extent throughout 2018?

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

There's a little bit of carryover, Stephen, but not material, not significant. We got the majority of our boost in the fourth quarter from -- and it was primarily Irma and Florida where we generated the most incremental work.

[Stephen Hardy Sheldon, Analyst]

Okay. That's helpful. And then, can you maybe talk some about the cross-selling opportunity between residential and the brands business? I'd imagine there would -- should be some opportunities. So just, yes, curious what your viewpoint on where the company is in terms of capitalizing on that, if you see that opportunity?

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

Yes, there are -- there certainly are opportunities, and we've been taking a closer look at it over the last couple of years, really since the spinoff, and we've focused our efforts on Paul Davis and CertaPro, in particular, and we're piloting, I would say, in initiatives where those brands have created a compelling offer for FirstService that benefits our clients. And so we're seeing some traction, but it is a long-term opportunity that we are taking one step at a time.

[Operator]

And next, we have a question from Matthew Burrus from Raymond James.

[Matthew Burrus]

Can you isolate for us the positive impact the hurricanes had on FirstService brands in the quarter?

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

About 5% or 6% of the growth was from the hurricanes and again, primarily Irma.

[Matthew Burrus]

Okay. Okay. And then, do you see any declines losing this kind of one-time hurricane benefit going forward?

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

Yes. I mean, it's something that we generated during the quarter. We'll get a little this quarter. But certainly, from those disasters, we're largely through with our incremental work. In terms of the organic growth in the Brands division, we've generated, I think Jerry mentioned it in his prepared comments, in the 10% range really every quarter this year, and for the year, it rolled out at 10% or 11%, and we expect that level through the first couple of quarters in 2018.

[Matthew Burrus]

Okay. And further, on margins at FSR. You've commented on the tight labor market and trying to be selective with renewals on that. Do you expect to hit a wall? Or do you expect to hit some pressure on margin expansion, margin improvement as the labor market continues to tighten and wages continue to rise?

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

Yes. It is a very tight labor market today, and we are seeing wage pressure, and we expect it to continue, '18, '19, '20, there are a number of states and provinces that have planned increases in minimum wage and other initiatives related to exempt staff and minimum salaries. And so all of that will ripple through and result in more wage pressure. In many cases, we're able to pass it on directly because we have sited staff and cost plus contracts. But there's a large portion of our business where those increases will be negotiations with our clients. And we expect that we'll be able to pass them through in time, if not directly. So to answer your question more directly, we will -- it certainly will impact our margins, but it's not clear to what extent. And we believe, in time, we'll be able to pass through the wage increases in its entirety.

[Matthew Burrus]

Yes. So now that you've crossed the 8% threshold, do you guys look at 9% margins at FSR? Or do you think this expansion will start to slow?

[Jeremy Alan Rakusin, Chief Financial Officer]

It's possible. As I've said in some of the earlier questions, the incremental margins that we expect over the next couple of years from the streamlining initiatives are still on the board. And so we think that can offset any wage pressure for the next couple of years. When we get to -- if and when we get to 9%, is unclear. We're at 8.5% now, and we expect to get little bites in 2018 and '19. And that's all we have in terms of time horizon on the margin front.

[Operator]

And the last question we currently have in the queue comes from Marc Riddick from Sidoti.

[Marc Frye Riddick, Research Analyst]

I wanted to touch on -- you had touched about some of the strength that you're seeing in the marketplace and the acquisition pipeline. And I was just wondering if we can get a little more color on that, particularly maybe if you could sort of give us a sense of, maybe, whether there were some particular areas of strength regionally? Or if there are any particular brands that you think that will take a greater step forward this year?

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

So Marc, I heard you touch on organic growth and acquisitions. So I'll answer it on that basis. The home improvement market continues to be strong. We benefit at California Closets from that. And Floor Coverings International, CertaPro Painters, so we do have some tailwinds on the brand side. Century benefits from these strong commercial real estate development markets, which benefits its sprinkler and alarm installation business. Again, some tailwinds. And we are -- as businesses continuing to improve and take share. And again, particularly within our company-owned operations, I would say. So we -- just answered another question around organic growth at Brands being in the 10% range, we really think that the strength of the markets will help us get there. In terms of acquisitions, we worked very hard at creating opportunities across Fire Protection and our company-owned strategies and across the FirstService Residential spectrum, including management companies, but also, ancillary service companies. And our pipeline has been, I would say, pretty active the last 2, 3 years, consistently.

[Marc Frye Riddick, Research Analyst]

Okay. Great. And so wondering if you could touch a little bit on the pricing disciplines that you've worked on, and certainly, I mean, it could be around the renewals, but I just wanted sort of to get a sense of, maybe, where you are in that process of pricing discipline? And whether -- what inning you're in, and sort of getting to where you want to be?

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

We are where we want to be. There's no process, I would say. We're not actively culling accounts. It's just an approach to ensure that we are really allocating our labor. We are capacity constrained in all our businesses. And we have to be very disciplined around the business we take on and how we allocate that scarce resource, which is labor. And so we're really seeing it across-the-board, and it does impact on our organic growth. There are many of our businesses where we could, if we had the labor, be driving more revenue right now. But at the same time, I think you see it in our margins also.

[Operator]

All right. And we currently have no further questions in the queue.

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

Thank you, operator, and thank you, again, everyone, for joining us today.

[Operator]

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