FirstService Corp

TSX:FSV

Earnings Call Transcript 2019-Q4

[Operator]

Welcome to the fourth quarter year-end 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 the 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 5, 2020. I would now 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, Christina. Good morning, everyone. Welcome to our fourth quarter and year-end conference call. Thank you for dialing in. Jeremy Rakusin, our CFO, is here with me. I will open with a quick summary of our results and talk to some of our highlights, and then Jeremy will walk you through the quarterly results in more detail and also summarize the full year. Let me open by saying that we are very pleased with the way we finished the year. The fourth quarter played out largely as we had forecast, and we feel like we are in a very good position entering 2020.Revenues were up 34% over the prior year, primarily due to the acquisition of Global Restoration at the end of the second quarter. Organic growth was 6%, which is a result we are very pleased with knowing that we were up against a strong comparative quarter in 2018. EBITDA increased by 31% year-over-year and reflects a 20 basis point decline in consolidated margins, primarily as a result of the mix change from the inclusion of Global. And earnings per share were up 6%, tempered relative to the EBITDA increase due primarily to our higher share count. Jeremy will provide more detail in his comments. At FirstService Residential, revenues grew 11% in total, 7% organically. The organic growth was broad-based across all regions and continues to reflect the strong sales activity in late 2018 and the first 6 months of 2019. We also saw stronger-than-expected ancillary revenue during the fourth quarter, which mildly influenced the organic growth number. Top line revenue growth also reflected the Chicago acquisitions completed early in the year. We added Lieberman Management Services in the first quarter as well as DK Condo, the condo management division of Draper and Kramer. Our teams have started working through the systems and process integration. And in the fourth quarter, the operations were rebranded FirstService Residential.The Chicago business in the aggregate performed very well for us in the fourth quarter, ahead of expectations, all while going through significant transition. It's a great reflection on our leadership team in the Chicago market and the operating teams at FirstService Residential.Moving on to FirstService Brands. Revenue was up over 70%, which is almost entirely due to acquisitions as organic growth for the quarter came in at 2%. The acquisition growth was primarily related to the original Global Restoration deal, but also included late-year tuck-unders at Global and several tuck-unders at Century Fire that were completed over the last 12 months. We were pleased to show positive organic growth in this division for the quarter. Solid results at most of the brands, particularly Century Fire and California Closets, more than offset steep year-over-year declines at Paul Davis, which reported a very strong fourth quarter in 2018, driven by hurricane-related restoration work. The Brands division in total generated 14% organic growth last year. So we had a big hill to climb, and as I said, we are pleased with the end result. During the quarter, we were also very pleased to report the 4 tuck-unders to our Global platform. These transactions, 3 in the U.S. and 1 in Canada, add to our footprint and strengthen our position with national accounts, both insurance carriers and multi-location Fortune 1000 corporations.Equally important was the influx of talent that came with the acquisitions, including several leaders who we expect will take on broader roles with us over the next few years. Another quarterly highlight that I want to mention was our $200 million equity offering that closed in December, a very important step for us that provides ample capacity to continue to drive growth across all our platforms. The offering was a milestone for us as it was our first equity raise since 1998. Our top line compound annual growth over the 21-year period since is almost 20%, which is remarkable. We've been able to grow at that rate for that long, financed with internal cash flow and modest debt levels. It really highlights the strength of our cash flow business model. Jeremy will talk a little more about the equity offering and its impact in his comments. Looking forward, with the balance sheet capacity we now have and coming off a solid fourth quarter, we feel very good about our positioning as we head into 2020, and we expect to post another strong year of growth this year, top and bottom line. And on that note, I will transfer over to Jeremy.

[Jeremy Alan Rakusin, Chief Financial Officer]

Thank you, Scott, and good morning, everyone. As Scott just summarized, we capped off 2019 by delivering a strong fourth quarter financial results. On a consolidated basis, quarterly revenues were $676 million, up 34% versus the prior year quarter. Adjusted EBITDA came in at $63.9 million, up 31% and adjusted EPS at $0.66, up 6% versus Q4 2018.The robust finish to the year helped reinforce similar strength in our consolidated annual financial results, which included revenues of $2.41 billion for the year, up 25%, including a very strong 7% overall organic growth. Adjusted EBITDA of $235.2 million, up 23%, with a 9.8% margin, relatively comparable to the 9.9% level in 2018 and adjusted EPS at $3 flat, up 15% versus 2018. As disclosed in 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 with the approach adopted in prior periods. As I typically do, let me now turn to a quarterly segment review of our 2 reporting divisions, FirstService Residential and FirstService Brands. Starting with FirstService Residential, revenues were $347 million during the quarter, an 11% increase versus the prior year period. Our EBITDA came in at $29.8 million, up 15%, driven by both the very strong organic top line growth that Scott described and 30 basis points of margin expansion quarter-over-quarter. These quarterly results largely mirrored the full year performance, with annual 2019 revenues for the division up 13%, including the same 7% strong organic growth as in Q4 and improved profitability with a 9.2% margin, 20 basis points higher than the 9% level in 2018.Next, let me summarize our FirstService Brands division results. In the fourth quarter, we reported revenues of $329 million, up 72% year-over-year and EBITDA increased 59% to $38 million. For the full year, performance was also strong, including 47% total revenue growth along with a 34% increase in EBITDA. Solid 6% organic growth for the year, together with the large global acquisition and other tuck-unders drove the annual results. In terms of profitability, we saw margins contract within the Brands division for both the fourth quarter and full year periods, down 90 basis points and 120 basis points, respectively. Just as we commented in Q3, 2 dynamics were contributing factors; first, acquisition mix from the addition of Global Restoration with lower margins than Brands, and second, lower activity levels in our Restoration operations. As Scott mentioned, we are ultimately very pleased with the quarterly and annual performance we achieved within the FirstService Brands division in the face of a strong headwind in our restoration sector, particularly in the back half of the year. 2019 also marked a watershed year of significant transaction activity, and I'll cite just a couple of examples. First, the $500 million Global Restoration transaction represented the largest acquisition in the 30-year history of FirstService. To initially fund that transaction, we received tremendous support and endorsement from our banking syndicate. And then to recalibrate our capital structure during the fourth quarter, we completed a $200 million equity offering, a rare event for us, as Scott noted. And so turning to our 2019 year-end balance sheet, net debt currently stands at $645 million, resulting in leverage of 2.4x net debt to 2019 adjusted EBITDA, roughly 1 turn higher than 2018 year-end but significantly pared down from our 3.2x leverage level post Global acquisition at the end of the second and third quarters. With our business model and free cash flow potential, we are very comfortable with leverage in the mid 2x range. The equity offering further fortified our liquidity as well, providing us with roughly $380 million of combined cash on hand and available draw on our revolving credit facility to drive further growth.Now to the components of our 2019 free cash flow. The fourth quarter cash flow after working capital of $43 million was more than double the prior year quarter and contributed to the $108 million of operating cash flow for the year. Capital expenditures for 2019 came in at $47 million, lower than our guidance during the year. On the acquisition front, beyond the Global Restoration transaction, we deployed an additional $75 million on 14 other tuck-under transactions. We were particularly active during the year with several acquisitions within our FirstService Residential and Century Fire platforms. Towards year-end, our Global Restoration business also added 4 regional tuck-unders, which will help drive additional growth in 2020 and beyond. Collectively, our 2019 tuck-unders, which exclude the large Global deal, generate in the order of $120 million in additional revenue on an annualized basis or roughly 5% of our total annual revenues. The deal pipeline today also continues to remain solid. I wanted to note as well our announcement yesterday that our Board of Directors approved a 10% dividend increase to USD 0.66 per share annually, up from the prior USD 0.60. This marks the fifth consecutive annual dividend increase of 10% plus, resulting in 65% cumulative dividend growth since our spin-off into a public company in mid-2015.As mentioned in my earlier comments, our balance sheet remains strong, and we have significant capacity and flexibility to fund the $27 million of increased annual dividends and yet continue to drive our growth. Lastly, let me wrap things out with our 2020 outlook. On the top line, we are forecasting consolidated organic growth in the mid-single digits with relatively similar contributions from both our Residential and Brands divisions. Consistent with our messaging over the years to target an all-in annual revenue growth of 10% or more, we will look for our tuck-under acquisition program to fuel an additional 5% or so of growth. And then finally, the additional impact of the Global acquisition for the first half of 2020 will further bolster our expected growth for the full year. From a margin perspective, we expect our 2020 annual consolidated EBITDA margin to be largely in line with the 2019 level with the margins for each of the divisions, FirstService Residential and FirstService Brands, being roughly flat with prior year. This is all consistent with our prior comments that our growth at this juncture is largely top line driven. On our tax rate, we expect in the order of 25% going forward, in line with the 24% effective rate we realized in 2019. And finally, we expect maintenance capital expenditures to be in the $60 million range, an increase over last year commensurate with the growth of our businesses. This now concludes our prepared comments. I please ask the operator to open up the call to questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from George Doumet from Scotiabank.

[George Doumet, Analyst]

Scott, on last call, you mentioned that leads were slowing in California Closets and CertaPro. The results don't really show any moderating growth. So is it -- do we still expect a soft patch ahead? Did the outlook improve since last quarter? Or are we pulling some execution levers to offset that?

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

I would say that in the home improvement brands, the leads have been steady the last 6 months or so. They are, I would say, down from earlier in 2019, but they remain steady. And in December, we did see the sale of existing homes in the U.S. pop by 10% year-over-year and the average home prices were up by almost 10%. Both those moves are higher than we've seen in the last couple of years, which should be good for home improvement spending. So our expectation is that at least for the first couple of quarters will show solid and continued results at the home improvement brands.

[George Doumet, Analyst]

Okay. And maybe moving over to the Restoration business. We've closed quite a few regional tuck-unders for Global. I guess following that, are there any geographies or maybe specific competencies that you feel that you're still a little bit under indexed in?

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

I think western U.S., perhaps California, in particular, would be one area, but also the Mid-Atlantic region are regions that we've strategically targeted to add to our footprint. But we feel very good about the tuck-unders that we've completed in the fourth quarter. I feel like we've gotten off to a great start and filled out our footprint nicely moving into 2020.

[George Doumet, Analyst]

Okay, great. Maybe, my -- one last one, staying on the restoration side of the business. Can you talk a little bit about the progress that we've made on adding -- I guess adding national accounts and maybe increasing share within the ones we have exactly, maybe any color or any detail you can provide there?

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

Well, only that we feel very good about our progress. We've invested in our sales team. We signed several accounts in the 6 months that we owned Global. And we feel like we've improved our positioning with existing national accounts. The collaboration between Paul Davis and Global has led to some progress with other national accounts. It's a combined, it's a compelling offer with the Paul Davis footprint. So we're excited about the momentum to date. And I mentioned last quarter, we will rebrand this year. And we think that will help increase the momentum once we do that later in 2020.

[Operator]

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

[Stephen MacLeod, Analyst]

I just wanted to circle around on the FSR business. You talk a little bit about the expectation for mid-single-digit growth going forward. Through 2019, it trended sort of well into that high single-digit range. So just curious, would the key driver of that have been the real push on the sales side? Or is there something else that's driving -- that drove 2019 that isn't expected to recur in 2020?

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

I think it's just a tapering of the sales. We saw very strong sales at the end of '18 and beginning of '19. I noted in our last call that sales had slowed down in the third quarter, which continued into the fourth, and we will see that reflected in the organic growth in 2020. So it's just a -- I think a rebalancing of the sales and retention, which are the 2 key levers, and it's trended back towards the average that we've seen over the last several years.

[Stephen MacLeod, Analyst]

Okay. That's helpful. You talked previously on the brand side about the California Closets centralized manufacturing initiative generating 300 to 500 basis points in margin expansion on that side of the business. Can you just talk a little bit about where you are in terms of that project kicking in and beginning to show on the margin for the brand side?

[Jeremy Alan Rakusin, Chief Financial Officer]

Yes, Steve, yes, the 300 to 500 basis points would be -- or 300 basis points or more will be incremental and gradual. We're not at point yet where we have the 2 facilities, the west and the east manufacturing centers operating at capacity with full lines for 25 or more. We did 2 acquisitions at the beginning of this year and are waiting for additional ones to add to the 19 that we currently have. But we're making steady progress, both on the manufacturing side and seeing the margin improvements at each individual company-owned location and then the quality is always something that we're looking to see, and we've made great strides in that as well as turnaround times. So we're being more efficient, higher quality and stand-alone margin metrics are all improving. Still more to come in that as we add to that roster of targeting 25 or more locations.

[Stephen MacLeod, Analyst]

Okay. And bridging the gap from 19 to 25, do you expect to do roughly -- I mean not pinning you into a corner, but sort of 2 a year kind of thing?

[Jeremy Alan Rakusin, Chief Financial Officer]

Yes, 2 -- it's obviously slowing, because we were looking for the most attractive ones. If we can do 2, that would be a good year.

[Stephen MacLeod, Analyst]

Okay. Okay, that's helpful. And then maybe just finally, sticking with the brand side, on the Restoration businesses. Obviously, a little bit of lumpiness in the back half of the year in terms of the comparability on the Paul Davis and Global side, in terms of weather-related activity levels. As you think about the mid-single-digit growth rate for 2020, do you expect the growth in Paul Davis and Global to be weighted to the back half of the year naturally?

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

Not necessarily. I think our expectation is that we will see modest growth out of those operations. And if we do see storm activity in the back half, that will be incremental. But we're assuming that we will experience sort of mid-single-digit organic growth off a base that we acquired and then the storms would be incremental.

[Operator]

Your next question comes from Stephen Sheldon from William Blair.

[Stephen Hardy Sheldon, Analyst]

Congrats on the results. Just one for me. On free cash flow, I know timing of items can have an impact, but free cash flow growth was a little slower than adjusted EBITDA in 2019. And apologies if I missed this, but just as we think about 2020, how are you thinking about a reasonable expectation for free cash flow conversion or just general generation during the year?

[Jeremy Alan Rakusin, Chief Financial Officer]

Yes, free cash flow should be typically in lockstep. There were some items this year, you'll see a deferred tax line item, but it's growth in lockstep with EBITDA, free cash flow as a percentage of EBITDA, excluding working capital in the 50% range, and then it really depends on working capital moves and that really is dependent on -- a little bit on the restoration sector and timing on accounts receivable and so on. But not much different than what I've said before in terms of kind of 50% free cash flow as a percent of EBITDA metric.

[Operator]

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

[Matt Logan, Analyst]

Just following up on Steve's question for organic growth in the residential division. Can you talk about the impact of condo development and what contribution that's having to the resi organic growth?

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

Condo development has been stable over the last few years, Matt, and it's in and around 20% of our organic growth. And maybe a little less the last half of 2019, where the organic growth popped a bit as a result of our sales activity. And that sales activity was largely around existing high rises and large master-plan communities. So -- but on average, over the last several years, it's been around 20% of our organic growth.

[Matt Logan, Analyst]

And when we think about the organic growth for the Brands division, certainly, the [indiscernible] loss activity was a little bit light in 2019. If that storm activity reverts to, say, the 10-year average, how should we think about the potential sensitivity of that mid-single-digit growth rate?

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

We would see it increase certainly. Restoration is...

[Jeremy Alan Rakusin, Chief Financial Officer]

It's 20% of our overall business.

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

Within that division.

[Jeremy Alan Rakusin, Chief Financial Officer]

It's sort of half-ish right?

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

Yes. And so yes, if we reverted to the 10-year average, that would actually be a significant increase for that platform. So we would see an increase in organic growth. I won't attach any numbers to it.

[Matt Logan, Analyst]

But in terms of order of magnitude, would that be 100 basis points or 300 basis points? Like just trying to get some sense of what the potential upside could be depending on kind of where weather patterns trend.

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

Yes. Well, the 2019 major storms were, in terms of storm damage the cost of storm damage was about 60% of the 10-year average. So if -- we would see a potentially significant...

[Matt Logan, Analyst]

So a pretty sizable increase.

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

Yes.

[Matt Logan, Analyst]

Okay. And maybe just rolling it all up, would you mind talking about maybe your top 3 goals for the business in 2020? And what gets you most excited when you look out over the next 3 to 5 years?

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

It's continuing to enhance our sales platform, I would say, and continuing to add national accounts and increasing the share of wallet with existing customers. So that's about market share, number one. Number two would be building out our branch network. And that is -- will largely be through tuck-under acquisition, but also could be a greenfield start, and we're looking at that in a few areas. And so building out that platform, again, that's about positioning with national accounts. And then, of course, I talked about the rebranding, which is a big goal of ours and a high priority this year. We're very excited about bringing the 6 brands that we operate under today under one name, with a one vision and a unified message. We think that's going to be powerful for us, again, in terms of market share. And ultimately, the goal is to be the leader in commercial restoration in North America, and we see a clear path to that.

[Matt Logan, Analyst]

And would you say restoration is still the top focus for 2020 and kind of beyond?

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

Across FirstService?

[Matt Logan, Analyst]

Yes, across the whole company.

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

I would say so, yes.

[Operator]

Your next question comes from Marc Riddick from Sidoti.

[Marc Frye Riddick, Business and Consumer Services Analyst]

I wanted to just sort of dig a little bit into some of the investments that you talked about. I guess on the last call, you've touched on it a little bit around the rebranding, but I think you didn't make a mention of maybe IT spending, personnel. So I was wondering if you could sort of give maybe a little bit more detail on how we might see that in the flow of that through the year. And then I have a quick follow-up after that.

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

Well, to support the brand, we will need national infrastructure and systems that will enable us to scale and grow. And we step-started down the path, as you suggest, I mentioned it last quarter, it will be a multi-year initiative, but we will stage it and take it one step at a time. The big thing this year is really the rebrand and the marketing spend around that. But there is investment in technology, but not that -- not at a level that will significantly impact our margin. I think Jeremy mentioned that we expect our margin in Brands to be flattish, to be in line with 2019, and that takes into account all of the spend that I'm talking about.

[Marc Frye Riddick, Business and Consumer Services Analyst]

Okay. But from a timing perspective, how should we sort of think about the way that, that would sort of play? I mean it might be a little -- some of that might be a little more difficult to be visible to us, I suppose. So how should we think about sort of that process for you throughout the year? Is there anything lumpy that we should be aware of that you think or just maybe it's already started to some degree, but maybe if you could...

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

No, it certainly has started. The actual rollout of the brand will be towards the end of the third quarter and the fourth quarter. So there will be a little more spend, but I wouldn't expect that you'll see it in the margin or I wouldn't expect that we would call it out as something that's tilted our margin.

[Operator]

[Operator Instructions] Your next question comes from Frederic Bastien from Raymond James.

[Frederic Bastien, MD & Equity Research Analyst]

Just one quick one for me. I wanted to touch on your successes in -- with new condo developments. With urbanization trends only getting stronger, one would expect that FSR would see increased competition in that segment. Just wondering what makes you confident that you can retain a dominant share of that market?

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

Well, urbanization implies highrise. And just in terms of the sheer scale of our highrise business relative to our competitors, it's probably 5 or 6x in terms of the number of urban highrise properties we manage. And so our knowledge, leadership in that area, our ability to benchmark and compare buildings in terms of energy efficiency and operating costs, it becomes a compelling differentiator. So -- and our position in the urban areas is generally -- we're #1 in really every major metro area in North America. So we expect that, that leads to scale and value for our clients. But certainly, our competitors -- we do have quality competitors in most of the urban markets, certainly.

[Operator]

There are no further questions. I would now like to turn the call back over to CEO, Scott Patterson, for closing remarks.

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

Thank you, everyone, for joining us. We're excited about 2020, and the opportunity we have in front of us. And we look forward to end of April, first quarter call, meeting again.

[Operator]

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