Earnings Call Transcript - BV Q3 2022

Operator, Moderator

Good morning and welcome to today's BrightView Holdings Incorporated Third Quarter Fiscal 2022 Results Call. My name is Bailey and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to our host Faten Freiha, Vice President of Investor Relations. Please go ahead.

Faten Freiha, Vice President of Investor Relations

Thank you, operator, and good morning everyone. Thank you for joining BrightView's third quarter fiscal 2022 earnings conference call. Andrew Masterman, Chief Executive Officer; John Feenan, Chief Financial Officer; and Brett Urban, Incoming Chief Financial Officer are on the call. Please remember that some of the comments made today including responses to questions and information reflected on the presentation slides are forward-looking and actual results may differ materially from those projected. Please refer to the company's SEC filings for more details on the risks and uncertainties that could impact the company's future operating results and financial condition. Comments made today will also include a discussion of certain non-GAAP financial measures. Reconciliations to comparable GAAP financial measures are provided in today's press release. Disclaimers on forward-looking statements and non-GAAP financial measures apply both to today's prepared remarks as well as the Q&A. I'll now turn the call over to BrightView's CEO, Andrew Masterman.

Andrew Masterman, CEO

Thank you, Faten, and good morning, everyone. We are pleased to report another strong quarter, showcasing momentum in our fundamental business drivers and the resilience of our model. I want to thank the BrightView team for their dedication and hard work in a rapidly changing environment. Their contributions fuel our performance and keep us positioned for long-term success. In today's call, I will provide a high-level review of our third-quarter performance, discuss our key growth drivers, detail the external challenges facing our durable business, and outline the confidence behind our optimistic long-term outlook. To begin with Q3 performance, we achieved strong organic growth for the fifth consecutive quarter, implemented strategic pricing initiatives, and navigated various external challenges with determination to position BrightView for enduring success. We continued to execute our successful M&A strategy, advanced our ESG initiatives, and enhanced our value proposition to customers through technology investments, all while contending with rising fuel costs and ongoing inflation of materials and labor. Our emphasis on organic growth and profitability improvement will allow us to leverage our scale to further enhance our growth and deliver exceptional value to our shareholders. Looking at our financial highlights for the quarter, revenue grew by 11%, reflecting strong total organic growth of 5.6% and continued benefits from M&A transactions. Strong net new growth, increased ancillary services, snow removal, and pricing initiatives led to a total maintenance organic growth of 3.1% on top of the prior year's organic growth of 11%. Our maintenance business benefitted from significant growth in snow removal services due to a late spring and extended snow season. Additionally, our land business achieved 2.3% organic growth, contributing to the total maintenance organic growth of 3.1%, consistent with our expectations. This illustrates our business's agility and how our service mix in snow and land enables us to manage seasonality effectively. A robust rebound in our backlog resulted in development organic growth of 14%, demonstrating a continuation of our strong performance. We remain optimistic about our bidding pipeline and the overall momentum in the business as we focus on driving sustainable organic growth. We expect fourth-quarter maintenance land organic growth to be around 3%, aligning with our long-term goals, while development organic growth is anticipated to be about 8%. We are confident that our robust sales engine will continue to generate solid organic growth in fiscal year 2023 and beyond. Adjusted EBITDA stood at $94 million for the quarter, reflecting a year-over-year increase of about 1%. Our profitability faced challenges due to unexpected spikes in fuel costs, which rose by about $10 million compared to the previous year—around $1 million of this increase was due to volume, with the remaining $9 million attributed to price. We began implementing fuel surcharges in April, offsetting approximately $2 million of rising fuel costs. Consequently, fuel costs had a net impact of around $7 million on adjusted EBITDA. Excluding this additional fuel headwind, our adjusted EBITDA would have reached $101 million, an increase of about 8% year-over-year, exceeding our guidance range. The strength of our performance reflects the exceptional efforts of our team across over 280 branches. Adjusted EPS was $0.43 per share for the quarter, benefiting from recent share repurchases, strong revenue performance, and effective management of direct costs, labor, and materials. We are focused on executing our strategy, which is evident from the momentum in our business and is centered on three main pillars. First, we aim to achieve robust organic growth through our dedicated, locally driven sales force of over 200 team members focused on customers and new opportunities. Second, we invest in technology, digital services, and marketing to maintain a significantly differentiated customer value proposition and expand our market share. Finally, we execute strategic and accretive M&A transactions to enable efficient expansion in high-growth markets. Our strong organic growth performance over the last five quarters was fueled by substantial growth in new sales, as our sales force attracted new and larger customers. Over the past several years, we have increased average job size in the maintenance sector by more than 40% as we gained customers with larger demands and enhanced our share of wallet with existing customers. Our land maintenance business generated over $150 million in organic revenue growth during the last five quarters. Importantly, our growth outpaces the industry, which is expected to grow at 0.9% for 2022 according to IBIS reporting. In comparison, we project land organic growth of 4% to 5% and total projected growth of approximately 8% for fiscal 2022. Despite facing challenges, we are significantly outpacing the industry and continue to gain market share amid scope reductions in the landscaping industry. These reductions stem from two factors: natural desilting as plant life establishes requires less maintenance over time, and the current inflationary environment prompting some customers to reduce scope. We are seeing modest market growth below current inflation levels; however, landscape maintenance remains a substantial market with enormous opportunities, given our market share of around 3%.

John Feenan, CFO

Thank you, Andrew and good morning to everyone. I'm pleased to report on another solid quarter. We delivered strong organic growth in our Maintenance and Development businesses, and our team navigated through a challenging environment and managed through rapidly evolving external headwinds, including most notably the continued rise in fuel costs. We remain focused on our key investment pillars of cash generation, organic growth, mergers and acquisitions, and margin enhancement over time. Before I cover our financial results in detail, I'd like to give Brett Urban, our incoming CFO, a couple of minutes to introduce himself. Going forward, Brett will be leading our earnings calls.

Brett Urban, Incoming CFO

Thank you, John and good morning, everyone. BrightView is a durable business with multiple growth opportunities, and I’m excited to be part of this dedicated team. I have been with BrightView for seven years and have served as the head of the company's Financial Planning and Analysis Group, as well as CFO of our Maintenance segment. In my new role, as the company's CFO, I will follow in John's footsteps and support the team to execute on growth drivers that maximize our potential and expand our market share. In addition, I'll be focused on consistently growing our business, enhancing our balance sheet and executing on capital allocation plans that create long-term shareholder value. I’m fortunate to have John's guidance during this transition period, which will certainly position me and BrightView for success. Lastly, I believe engagement with our investors and analysts is essential to our long-term success. Working with Andrew, John and the team, I look forward to meeting and partnering with you all over the coming months. I will now turn the call back over to John, to cover our results.

John Feenan, CFO

Thank you, Brett. Let me now provide a snapshot of our third quarter results. Moving to Slide 14. Total revenue for the third quarter increased by 11% reflecting 5.6% of total organic growth. Total revenue growth was supported by increases in both maintenance and development segments. Maintenance revenues increased by 7.1% driven by 3.1% of total organic growth, which included 2.3% of land organic growth. Our total maintenance organic growth benefited from better-than-expected snow removal services, as a result of the longer than typical snow season, which offset ancillary services in April. Land organic growth was driven by strong contract growth and a continued rebound in our ancillary services. In addition, our pricing strategy contributed approximately 50 basis points to our land organic top line growth, net of scope reductions as expected. Last week, we realized $20.8 million of incremental revenue from acquired businesses. Development revenues increased by 24% compared to the prior year. The increase was driven by a combination of strong organic growth of 14% and M&A contributions of approximately $15 million. We remain encouraged by our pipeline and bid calendar, and we anticipate continued strong organic growth in the fourth quarter, of approximately 8%. As Andrew mentioned, we serve a diverse mix of end markets in our development business and we are seeing growth across all of these verticals most notably in public works and commercial construction projects.

Andrew Masterman, CEO

Thank you, John. We have a strong, resilient and agile business. We are leaders in our industry with an unparalleled customer value proposition, supported by our investments behind digital services and sustainability. We are executing against our growth initiatives and driving strong momentum in our business. Our investment in sales, technology and marketing continue to fuel our momentum. Pricing efforts will help us enhance our profitability and our excellent M&A engine will support further top line acceleration and expand our footprint. Our performance in the third quarter was excellent and we exceeded our internal expectations excluding the fuel headwind. We drove strong organic growth, offset our operational costs, labor and materials through price increases and our teams executed at the highest level. We expect this momentum to continue for the fourth quarter. And as we look out to fiscal year 2023, we continue to see a clear path to approaching $3 billion in total revenues. Importantly, our business generates solid free cash flow and the strength of our balance sheet gives us the flexibility to continue to invest in our business and drive shareholder value. Our model creates a cycle of high free cash flow and reinvestment capacity. The recurring revenue model drives profitable top line growth. And that in turn delivers strong free cash flow which is predictable and consistent over time, as evidenced by the generation of approximately $500 million of free cash flow over the last five years. All of these efforts along with the benefit of secular trends give us strong confidence in the long-term prospects of our business. Our future remains bright. And we are confident that we have the right strategy to accelerate our performance. In closing, I'd like to thank our customers for their support and partnership, and for working with us on managing the current inflationary environment. We are excited to see our customers' landscape blossom, as we move through our green season. Also I’m thankful for our teams, for their continued attention to designing, creating, maintaining and enhancing the best landscapes on earth. Thank you for your interest and for your attention this morning. We'll now open the call for your questions.

Operator, Moderator

Thank you. The first question today comes from Tim Mulrooney from William Blair. Please go ahead, your line is now open.

Tim Mulrooney, Analyst

Andrew, John, Brett, good morning.

Andrew Masterman, CEO

Good morning, Tim.

Tim Mulrooney, Analyst

So, I wanted to ask about your maintenance land business. You were forecasting 3% to 4% organic growth in the back half of the year. And it looks like the third quarter came in slightly below that at 2%. So, I was wondering if that was because you didn't get the net new contract growth that you were looking for this selling season or if maybe there was a slight pullback in enhancement spend could you just provide a little bit more color on the spending patterns that you're seeing within your customer base with a particular focus on how that enhancement piece of the business is doing? Thank you.

Andrew Masterman, CEO

Absolutely, Tim. Yes, it was a dynamic similar to what we saw a couple of years ago and that we had a late spring with snow coming in at the beginning of April. And so as we missed that window for ancillary installation because we had snow coming down that really was the offset. So, if we hadn't had the snow, we would have replaced it with ancillary. So, we saw a similar demand as we expected. It just we couldn't get to it because there was snow on the ground. And so it really was that straightforward.

Tim Mulrooney, Analyst

Yes. That makes sense. And we're hearing that from like the pest guys other similar industries were affected by a cold spring. So, that all makes sense.

Andrew Masterman, CEO

Exactly. And we continue to be very confident that as we go forward that continued growth right around 3% is what we should expect going forward.

Tim Mulrooney, Analyst

Okay. All right. That's helpful too. If I could sneak one more in. Just on pricing. Last time we spoke I think you expected about 50 to 100 basis points of organic growth in maintenance land come from pricing this year. And I know usually you get pricing through changes in scope. But this year you're actually expecting price to contribute to organic growth now that we're through that key selling season and with the fuel surcharge, I wanted to check in on that number and see how we should still be thinking about pricing this year if that 50 to 100 basis points contributing to organic growth is the right number or if it's a little higher or lower than that? Thank you.

Andrew Masterman, CEO

Yes, Tim, we are seeing about a 50 basis points impact from pricing this quarter. As you mentioned, the pricing season is mostly behind us, and we anticipate this trend will continue into the fourth quarter.

Tim Mulrooney, Analyst

Very helpful. Thanks, guys.

Operator, Moderator

Thank you. The next question today comes from the line of George Tong from Goldman Sachs. Please go ahead, your line is now open.

George Tong, Analyst

Hi, thanks. Good morning. I wanted to dive a little bit into fuel prices which remain a headwind. To the extent that fuel prices remain elevated, could you talk a little bit more about the strategies you have to manage through the impact? You touched on efficiencies and pricing anything directly related to hedging or pass-throughs that you can implement that can help mitigate any surprises or unforeseen changes in oil prices?

Andrew Masterman, CEO

Yes, George and obviously fuel was the biggest impact to our business here in the third quarter. And as we look at the fourth quarter we see fuel continuing to be at a relatively higher level compared to last year. What we continue to do is work with our customers on fuel surcharges. We feel like we've pretty much completed the discussions with those customers to be able to continue to receive the surcharges as long as fuel remains above that kind of $3.50 level and so we're able to protect it there. Fuel hedges we did not hedge in 2022 for 2023 because we saw escalating fuel prices continuing to raise and we're concerned a little more about the volatility that we would see at fuel. And the last thing I think anyone wants to do is to see the hedge of the peak and when fuel prices potentially came down. So, that's why we didn't hedge before. We'll think about it again as we look at every year about hedges as a potential mechanism to be able to offset the fuel. But at this point in time given where fuel is at we have not placed any additional hedges as we look forward into Q1 or Q2 2023.

George Tong, Analyst

Okay, got it. That's helpful. You talked a bit about market impact that you're seeing from inflation as it relates to material and labor in your development business. Are you seeing any easing of trends or peaking of trends here, or is the momentum still sort of up and to the right as it relates to input costs?

Andrew Masterman, CEO

Yes, I want to emphasize that we believe we have moved past the peak and are on the other side of the curve. As we moved through the third quarter, we noticed a significant reduction in the negative impact on our development segment. We expect that as we enter the fourth quarter, we will start to see a positive shift, which we've anticipated for several quarters. We needed to reach the latter half of summer into fall, and we are indeed observing improvements in our material rates. This is due to transitioning from contracts with historically longer lead times to newer contracts that have much shorter lead times. We anticipate a positive change on the material side. On the labor front, our teams in both development and maintenance segments have excelled in managing labor effectively. Our results reflect our ability to navigate the labor environment, with fuel being the only significant impact, and overall results aligning closely with our expectations, aside from commodity fluctuations. The insights we've gained from fuel trends give us confidence moving forward. This success is also linked to the technology we've implemented, such as electronic time capture and labor management tools, which have enabled stringent management across both segments in our business.

George Tong, Analyst

That’s great. Thanks very much.

Operator, Moderator

Thank you. The next question today comes from the line of Justin Hauke from Baird. Please go ahead. Your line is open.

Justin Hauke, Analyst

Yes. Can you hear me now?

Andrew Masterman, CEO

We can now, Justin.

Justin Hauke, Analyst

Thank you. I'd like to ask about the balance sheet and cash flow. For the fourth quarter, I understand the M&A contribution will be similar to what it has been, around $35 million per quarter. Looking into 2023, with leverage at 4.8 times, I'm interested in how you plan to maintain this level of M&A activity next year. I ask because some cash flow challenges from this year are likely to persist. Next year, there's another repayment from the CARES Act that I believe is due in December. Additionally, your interest expense guidance for the fourth quarter suggests an annualized figure of about $80 million. I'm curious about your thoughts on free cash flow for next year and your ability to continue utilizing the balance sheet as you have in recent quarters.

John Feenan, CFO

Yes, there’s a lot to unpack in your question. When we analyze this year’s cash flow, it has certainly been influenced by three main factors. First, the rise in capital expenditures, which we expect to stabilize at around 3.5%. Second, we experienced the unwinding of the CARES Act, resulting in about $34 million to $35 million in effects. Lastly, there was an increase in cash taxes reflecting a more standard rate this year, especially since we benefited from tax planning in the previous year. Looking ahead, we are confident that our cash flow will return to our historical average. Over the past five years, we’ve averaged around $0.5 billion, or about $100 million per year, and we believe this target is still within reach. As we consider next year, we have indicated that we expect to approach $3 billion in revenue. We anticipate growth, which will present some challenges in working capital. We also expect a rise in interest expense mainly due to higher rates and an increase in SOFR. However, there are positives to consider. As we grow, we expect incremental EBITDA. Although we'll have outflows related to the CARES Act in the first half of fiscal 2023, we plan to implement tax strategies that should more than offset these payments, likely exceeding them by 1.5 to 2 times. We remain confident that our cash generation will be in the range of $90 million to $100 million, which aligns with our average over the last five years, allowing us to pursue our M&A strategy.

Justin Hauke, Analyst

Okay. So $90 million to $100 million is projected for next year. I don't have much detail on the profit and loss statement since you covered the fuel impact well, and it seems like labor costs are mostly being balanced by your actions. I'm curious about the IT expenditures this year—how much more is there to spend on that? Will that decrease after the fourth quarter? Additionally, regarding the excluded items like COVID expenses, how much longer will they affect the results on a GAAP basis?

Andrew Masterman, CEO

Justin, let me talk about the IT and maybe John can then pick up on the COVID expenses. But our IT pipeline that we have for initiatives around digital implementation of tools actually has a pretty long horizon when I look over several years. And these tools are things which will engage customer engagement things like HOA and BV Connect 2.0 that's going to be coming out. That's only 2.0. There are actually constructs out there what 3.0 could look like. And as we continue to enhance that combined with tools that help us in our ancillary management, help us in our tree care management things that think about employee engagement. There are multiple tools that we have out as we continue to transform this industry into a really a more digital and future-focused organization that will not only drive better customer retention and employee engagement and employee retention, but also look at growth initiatives in our digital marketing spend and our approach to digital. So that IT spend, I don't see coming down and I see the opportunity is fairly significant as we continue to deploy that. Fortunately, that mostly happens in a capitalized way. So we don't foresee that to be an expense headwind at all. And John I'll have you.

John Feenan, CFO

Yeah. And Justin on the COVID, we expect that to drop precipitously going forward. We have started to see that this year. We're down about $2 million sequentially from Q2 to Q3. We expect that to continue to drop quite a bit, where it will be I would say de minimis in fiscal 2023.

Pete Lukas, Analyst

Hi. Good morning. It's Pete Lukas for Bob. Just looking at it, due to cost inflation, scope changes et cetera, it's kind of hard to gauge the underlying growth of the business in terms of net number of contracts, revenue per contract. Just wondering if you could comment a little bit more on how these have trended and give us a little sense and any kind of clarity or more info you can give us on that? And also, is there a better way to look at growth there?

Andrew Masterman, CEO

Yeah, sure. And I can give you certainly, we looked at price and the impact of price being about 50 bps in the quarter. Outside of that, it's really a combination of contracts and ancillary. We saw some rebound in ancillary, but ancillary is pretty much running at historical levels. So we continue to see net new contract improvement, which basically that's underlying growth. And we saw that in the first quarter, we saw the second quarter and we're seeing in the third quarter and we're going to see in the fourth quarter. And we see that because our contract wins that we've got in the third quarter we see that kind of spill out and basically impact the next several quarters when it comes to contract growth. So we do see a significant amount of growth continuing to come into the business and net new contracts and then you look at the size of our contracts also those are growing. So we see our positive about the trends of the investments in our sales force really continue to pay off and will continue to deliver a sustainable picture. We've done five quarters of organic growth. Next quarter, will be our sixth quarter and we believe those quarters will continue. This is a steady machine that we expect to continue to deliver for the foreseeable future.

Pete Lukas, Analyst

Great. And just following up on that. In terms of the biggest focus for new wins, if you could kind of talk about that and what end markets do you think you have the biggest advantages there?

Andrew Masterman, CEO

It's a great question because this marketplace has many diverse elements and different types of customers. We're not seeing any specific customer type, but we are noticing that larger customers, those with a more sophisticated approach, are showing significant interest. This includes customers in commercial areas, homeowners associations, and parks and recreation. As customer size increases, so does the demand for our ancillary services, which we provide across our entire service suite. Our account managers are doing an excellent job of engaging with customers, emphasizing horticultural expertise and direct communication. The size of the customer is important, which is why we've increased our customer base by over 40% in recent years, focusing on contracts that require high levels of customer interaction and deliver real value. Instead of focusing on any specific vertical, it's more about the increasing size of our customers.

Operator, Moderator

Thank you. There are no additional questions waiting at this time. So I'd like to pass the conference over to Andrew Masterman for closing remarks.

Andrew Masterman, CEO

Thank you, operator. Once again, I'd like to thank everyone for participating in the call today and for your interest in BrightView. We look forward to speaking with you at upcoming events and we will report our fourth quarter results in November. Until then, stay safe and be well.

Operator, Moderator

That concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.