FirstService Corp Q1 FY2020 Earnings Call

Welcome to the first 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 materially differ 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 filed with the Canadian Securities Administration, 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 April 23, 2020. I would now like to turn the call over to Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

Thank you, Jessie. Welcome, ladies and gentlemen to our first quarter conference call. Thank you for dialing in. Jeremy Rakusin, our CFO, is on the line with me today. In terms of an agenda for the call this morning, I'm going to open and start right into a COVID-19 update, talk about the impacts the pandemic is having on our businesses, the actions we're taking and a look forward. We will then circle back and talk to you about our Q1 results as we normally do, Jeremy and I in tandem. And then Jeremy will close with a focus on our balance sheet and liquidity. Let me start by saying that all of our businesses have been designated essential services in at least some of their geographic regions, with most being granted essential status across every market. In particular, our management, janitorial, security, restoration and fire safety businesses are delivering services that are protecting the health and safety of our customers during this crisis. I can tell you, I am so proud and inspired by our frontline teams that show up every day and continue to deliver on our service excellence promise. Our customers are depending on us now more than ever, and I want to personally thank our operating teams for their resilience and commitment during this time. Although our services are deemed essential, they are certainly not immune to the impacts of a pandemic. While COVID-19 did not materially affect our first quarter results, we will see a negative impact in future reporting periods, in particular, the second quarter. The various lockdown, stay at home and social distancing measures are negatively impacting our ability to work on the premises of both residential and commercial customers. All of our service lines are being impacted with a more pronounced effect being felt within our brands division. Let me get a little more specific and talk about each of our divisions. We believe our FirstService Residential division will be relatively resilient. Most of the revenue is essential and contractual and relates to community management. Our boards are counting on us to deliver seamless management services through this period. We will, however, see declines in certain ancillary services, including amenity management, project management, and a number of administrative services. As a result, we expect year-over-year revenue decline in the second quarter of 10% to 15%. The ancillary services generally carry a higher average margin. So we expect some margin dilution in Q2 versus Q2 of 2019. Our FirstService Brands division will see a more pronounced year-over-year revenue decline, particularly as a result of our home improvement-related businesses. As mentioned, it is currently very challenging for our operations to perform on-site work and generate revenue. We expect our revenue in this division to be off 40% to 50% in the second quarter, excluding Global Restoration. With Global, we will be flat to up 15%. In terms of profit, we expect to generate a modest low to mid-single-digit margin in Q2. All of our operations acted quickly and boldly in March to reduce operating costs, including headcount reductions, salary cuts and deferral of all discretionary expenses. The Q2 margin estimates I have provided include all of these mitigating measures. We, like others, cannot predict the duration and severity of the pandemic, and it's difficult for us to see beyond Q2. In fact, I would say that May and June are not highly visible at this point. The situation changes daily. I will say that all of our businesses are mobilized and planning for a return to work. We are confident that we will respond quickly to changes in the marketplace and take full advantage of any and all revenue opportunities. We have a long track record of success, and we fully expect to get through this period of disruption and continue to build on it for years to come. Our performance in the first quarter was another building block in that track record. Pre-COVID, we had momentum, really, across the board that exceeded our expectations. Q1 results would have been even better, particularly in our brands division as our momentum, obviously, did slow in March. Total revenues were up 31% over the prior year, relating primarily to the acquisition of Global Restoration at the end of the second quarter of 2019. Organic growth was again 6% this quarter, spread evenly across our divisions. EBITDA increased by 50%, reflecting a 90-basis-point increase in margins and earnings per share were up 23%. At FirstService Residential, revenues grew by 6%, all organic. The growth was broad-based geographically and balanced between contract wins and the addition of ancillary services. At FirstService Brands, revenue was up 77%, due primarily to acquisitions, but supported by very solid organic growth of 6%. The organic growth was driven by strong results at Century Fire and the home improvement brands, particularly California Closets and CertaPro Painters. And the results at our home improvement brands are impressive in light of the considerable headwinds they faced during the last two weeks of March. I will tell you that we are very pleased with the results of our first quarter, which reflect market share gains across the board and strong fundamentals. On that note, I will transfer over to Jeremy for a more detailed review of our quarter and balance sheet.

Thank you, Scott, and good morning, everyone. As you heard, we kicked off the 2020 fiscal year with another quarter of strong financial performance. To recap our consolidated Q1 financial results, we reported revenues of $634 million, up 31% over the $486 million in the prior year quarter. Adjusted EBITDA was $43.9 million, a 50% increase over the prior year's $29.2 million, with our margin coming in at 6.9%, up 90 basis points year-over-year, and our adjusted EPS was $0.37, representing 23% growth over the $0.30 per share in the prior year period. Our adjustments to operating earnings and GAAP EPS in arriving at adjusted EBITDA and adjusted EPS, respectively, are outlined in this morning's press release and are consistent with our approach and disclosures in prior periods. Turning to our segmented financials by division. FirstService Residential recorded revenues of $340 million, up 6% over last year's first quarter, while EBITDA was $23.9 million, a 9.5% increase over the prior year. The EBITDA margin for the division came in at 7%, up modestly from 6.8% last year. In our FirstService Brands division, we generated revenues of $294 million during the first quarter, up 77% over last year's first quarter, which in turn, drove EBITDA of $21.9 million, double the $11 million in the prior year quarter. The division margin increased to 7.5% from last year's 6.6% level due to a shift in mix of businesses within the brand's portfolio. The current quarter included contribution from Global Restoration with its year-round operations compared to a more seasonal slant in Q1 '19 and prior years, which typically yielded lower first quarter Brands margins. Now on to a walkthrough of our cash flow which was strong across the board. We generated $31 million before working capital changes, a 27% increase year-over-year. Operating cash flow after working capital requirements was up even more, 56% over last year at $14 million. Cash flow improvement is largely attributable to the reduced seasonality in our Brands division versus the prior year, which I previously referenced as well as increased accounts receivable collection. During the first quarter, our capital deployment was modest. CapEx in support of our existing businesses was $15 million, tracking in line with the annual $60 million CapEx level we provided at the outset of the year. Scott alluded to the cost reduction and cash management initiatives we have undertaken in the face of COVID-19, and that includes a review of our capital expenditures. To counter the impact of the pandemic, we are reducing our estimated annual CapEx to a level in the order of $45 million, with an ability to flex either up or down as the degree and duration of the crisis plays out. Our other leg of capital deployment acquisition spending was negligible for the quarter compared to the deal flow we saw in Q1 2019. The acquisition activity we have ebbs and flows from quarter-to-quarter and year-to-year. So the more muted level this quarter is not indicative of any longer-term trend. While the current COVID-19 environment does make it more challenging to advance our deal pipeline, we continue to be active with our prospect list so we're well-positioned to further advance when travel opens up. The combination of improved cash flow and reduced capital investment kept all of the key metrics related to our balance sheet roughly in line with the 2019 year-end. Our leverage, as measured by net debt to trailing 12 months EBITDA, remained flat with year-end at 2.4x. We believe that this leverage ratio provides us with sufficient headroom compared to our maximum covenant of 3.5x to navigate through the COVID-19 environment. Our debt profile is also favorable. We have an attractive low-cost of funding with an average annual interest rate in the range of 3% to 3.5% based on our mix of current floating and fixed-rate borrowings. All significant debt maturities are at minimum close to 3 years out, with our bank revolver having the nearest-term maturity in January 2023. And most importantly, our liquidity, reflecting our cash on hand and our undrawn revolving credit facility balance is significant at $400 million, a little higher than at 2019 year-end. This liquidity level gives us plenty of runway to withstand the negative impact of the pandemic, particularly given our asset-light business model and ability to generate free cash flow in a highly depressed macroeconomic environment. That concludes our prepared comments. I ask the operator to open the call to questions at this point.

Your first question comes from George Doumet with Scotiabank.

Maybe on the brands side of the business to start off. I understand this is a tough question. But how do you see the eventual, I guess, the trajectory of the recovery in the back half? I guess, when you look at California Closets versus Restoration and versus Century Fire, maybe how you project that? How you think of that in terms of maybe some lags there? Just your views there, please?

Well, that is a tough question. George. It's hard to say. I will tell you that we had, as I said in my prepared comments, very strong momentum leading into this. At Cal Closets, we were building backlogs really at every operation. And we continue to engage with our customers and provide virtual estimates and virtual consults, but we simply are unable to get out and install the work. But the teams are ready to go. And as we are able to get back into homes, we'll start to work through that backlog. And how quickly that happens, we don't know. And the longer-term impact that this situation has on demand at our home improvement brands, we don't know that either. But I can tell you that there is lead activity that is certainly down, but stabilized and starting to tick up. So we're hopeful.

Okay. That's helpful. And you alluded to this earlier, Scott, on the residential side. Can you maybe talk a little bit about what specific service lines and maybe what end markets have been the most impacted to date? I'm just wondering if you're seeing any issues at all when it relates to collections?

Okay. So two different questions. At FirstService Residential, our core management services can continue. We manage 8,500 communities, and they're all expecting us to manage seamlessly through this period. So financial management, collection of assessments and payment of vendors and so on continues. In many regions, we provide a full-service offering that includes janitorial and front desk visitor screening, package handling, security, building operations, all of that continues seamlessly. But it's the management of fitness centers and spas in aquatic areas that they have, for the most part, been shut down, which results in a reduction of our staff. Project management, construction management or services we provide in many regions, it's slowed considerably. And then administrative services, transfer and disclosure documents, for example, that relate to the sale of a property within our communities. That activity, properties simply aren't moving right now. And so that's a fee that we charge for that service that will be down. And so it's those services that are resulting in the reduced revenue that we're forecasting for Q2. In terms of the collection of monthly maintenance fees, we haven't seen any impact yet. So that would be for April. There was a little bit of reduction in New York, but outside of New York, really nothing at this point.

That's helpful. And just one last one, if I may, maybe to Jeremy. As it relates to the covenant, I think you called them out at 3.5. Just wondering, in light of, I guess, all that lower visibility we're facing on both segments. Is there an attempt, maybe on your end, to raise those and just to be prudent?

Not at this point, George. We modeled out many different scenarios, but the way we see the outlook for Q2 and the parameters that Scott outlined shaking out, we think it would be premature to go there. We're pretty comfortable that we're going to stay within that covenant. Obviously, it's a fluid situation, we'll keep evaluating it, but we're in good shape right now.

Your next question comes from Stephen MacLeod.

I understand there is a lot of uncertainty right now. I was curious about the guidance you provided for Q2 regarding FirstService Brands. You mentioned two scenarios: one including Global Restoration and the other excluding it. The range of expectations varied from down 40% to 50% to flat or up 15% with Global Restoration. Can you clarify if this difference is due to including Global Restoration in this period when it wasn’t included last year, or are you actually experiencing significantly higher growth from Global Restoration?

It's the former. Just looking at the organic year-over-year situation in Q2 and then layering in Global, which I think a lot of people have modeled separately or looked at separately.

Could you provide some insights into the performance of the brands business so far this quarter, specifically regarding each service line? I know there’s been a lot of weakness, but can you highlight any areas where you might be seeing growth within the brands?

I can't report any areas of growth, Stephen. However, I would like to discuss the home improvement brands collectively as they are quite similar. The situation is unusual, as leads have certainly declined over the last six weeks, but they are stable and have started to increase slightly in the past couple of weeks. We are engaging with customers, providing estimates, and in some cases, booking jobs, but primarily we are unable to deliver services since 85% of North America has effectively been shut down. Until things begin to open up, we won't be able to convert these leads into revenue. Century Fire has been relatively resilient so far, with two segments of the business. One is tied to new construction, which accounts for about 45% of the revenue and has decreased only slightly. Some construction sites are inaccessible, but many are still operational and considered essential, with a strong backlog of work. Therefore, we expect to ramp up quickly in that area. The other segment is service, inspections, and repair, which has seen a more significant decline, paradoxically affecting the less cyclical part of the business due to customers being shut down, preventing inspections. Overall, Century Fire is down only modestly, similar to FirstService Residential, and the restoration segment has remained steady for us.

Okay, that's helpful. When you consider the numbers you've provided for Q2, do they assume that the recent stability continues for the rest of the quarter? Or do they account for a possible rebound? As you mentioned, you're beginning to see an increase in the home improvement business regarding job bookings and customer engagement.

No, we haven't. It really does change day-to-day, so we have not built any rebound into our Q2 expectations.

Yes, that's very helpful. On the FirstService Residential side, could you clarify if around 25% is a fair estimate of what portion of FirstService Residential revenues is currently under pressure regarding the transfer disclosure, aquatics, and spas? Is that the correct figure to consider?

It sounds right. Jeremy, do you want to?

Yes. That would be about right, Steve. 20% to 25%.

Your next question comes from Stephen Sheldon.

First, I wanted to ask what trends you have observed in residential client retention during the first quarter, particularly in March. Also, what do you anticipate for the second quarter and the remainder of the year?

We had a solid first quarter regarding sales and retention. Looking ahead, I believe retention will remain strong. I also don't anticipate boards of directors considering management changes during this disruption. Therefore, we expect our retention to likely improve during this time. However, it will be more challenging to attract new accounts and gain the attention of boards. As a result, we expect our sales to moderate as well. Still, the balance between retention and sales should remain relatively consistent.

Okay, that's helpful. Can you please restate the parameters you set for Q2?

For FirstService Residential revenue is down 10% to 15%. And there will be some margin dilution because the decline in revenue is from ancillary services, which on average, carry a higher margin. Brands, down 40% to 50% ex-Global, flat to up 15% with Global. In aggregate, low- to mid-single-digit margin.

Okay. That's helpful. And then as you think about the second quarter, I know you talked about furloughs and other things. Are there other expenses? And I think you said you'd maybe cut all the discretionary spend. I mean, are there any other expenses where you might try to rein in spend if trends in the second quarter deteriorate even more than expected?

The answer is yes. But I will tell you that we jumped on this early and boldly. And I must say I'm very proud of the way our teams approached this situation. They faced it head-on from the beginning. And the approach was to err on the side of being too aggressive. We did not know and really still do not know what we're dealing with, and we did not want to regret being too passive about this. So I'm very comfortable with the action we've taken. If the situation declines from where it is today, we will have to take further action. But I think we've done the right thing to date.

Your next question comes from Sumayya Syed.

Just firstly, typically, in residential, what are the ballpark margins for, I guess, the core property management business versus the more ancillary services?

Jeremy, I'll pass over to you.

Sumayya, everything around property management and the site staff, everything labor is kind of 8% to 10% order of magnitude. And on the more transaction-related services, 30% plus and incremental would be higher than that. But just as a current base, in that order. So it is much more significant than the labor services.

All right. Okay. I'm not sure if I missed it, but just can you go over how the Global and Paul Davis businesses have done post the shutdown period?

Global had a solid first quarter, which was generally consistent with the previous year, even though we did not own it in Q1 of last year. On an organic year-over-year basis, it was mostly in line. Last year, there was some hurricane work that carried over into Q1, and when adjusted for that, Global saw a net organic increase. We monitor this closely as it reflects our progress with national accounts. Global benefited from an uptick in commercial COVID work, particularly in April. There’s an expectation that the reopening and return to work will further boost this, leading to more specialist disinfectant services and initial deep cleanings in commercial spaces, which should help offset the decrease in weather-related claims that have been down for a few quarters. Paul Davis has also felt this impact. While Paul Davis has some COVID-related work, it has been affected more significantly due to its focus on residential projects, with many jobs paused because work is taking place in homes. As a result, residential claims declined throughout the quarter, and we anticipate this trend to continue into Q2.

Okay. That's helpful. And just lastly for me, a bit of a bigger picture question. I mean, obviously, your business has evolved and diversified quite a bit. And looking at the evolution, how do you see, I guess, the company's positioning today as better being able to go through the current downturn versus maybe a few years ago?

I believe we have successfully diversified our business, and the addition of Global has greatly contributed to that. We did not anticipate such outcomes when we acquired them. We appreciate the opportunities we have in restoration for both residential and commercial sectors, and that will benefit us during this period. Overall, we have improved in various areas and have set ourselves apart more significantly from our competitors. In many of our sectors, our leadership position is becoming more evident in the current environment, and we expect to emerge in a stronger competitive position. We are confident that our teams are performing well right now.

Your next question comes from Daryl Young.

My question is on the M&A landscape. Just looking out past the COVID period, if you're seeing or you expect to see an increase in the number of opportunities out there as some of your competitors may have struggled more through this reduced activity level period on both residential and on the brand side. Specifically, on taking some of the private equity players in the restoration space?

Yes. Well, there's that group, but there's also, really, the broad group of our competitors. We operate in fragmented markets, so really, in every business. Our competitors are primarily small, family-owned businesses. And I would say that they are generally very nimble and very entrepreneurial and a resilient group. But this is an unusual time, and they are not as well capitalized as we are. And some won't make it, and some may well be more amenable to acquisition. We will be very, I guess, aware and alert for those opportunities. We're not seeing it as yet, it's still early. But we maintain communication with a group of these companies, and we have for years and years and years, and we will continue to, and it's a very respectful relationship. And so we'd like to think that when those families do get to that point where it's time for them to exit, that we'll be the call that they make. In terms of the private equity restoration companies, those are all relatively new investments, and I expect that those businesses are well capitalized and will be formidable competitors for us over the next few years.

Your next question comes from Marc Riddick.

I apologize for the delay in joining the call; I may have missed some details in the opening minutes. However, I'd like to revisit a question similar to the last one asked. Could you provide an update on your thoughts regarding the acquisition strategies for the company-owned brands, particularly California Closets and Paul Davis? Additionally, do you think you are in a strong financial position to pursue opportunities for company-owned brands that may come up during this downturn? I would appreciate your insights on this matter.

We believe we are ready to take action. However, it will be challenging to finalize deals in the current environment until travel restrictions are lifted, as this affects our ability to conduct thorough due diligence and build relationships with key stakeholders. Nevertheless, we are making efforts to enhance our pipeline and continue seeking new opportunities. Regarding our strategies for California Closets and Paul Davis, we are still committed to long-term objectives. These initiatives will likely be on hold for a few months due to the reasons mentioned. However, as I indicated previously, the situation may facilitate discussions regarding franchises we aim to acquire, potentially speeding up those conversations.

I wanted to follow up regarding the current unemployment situation and its impact on jobs. In the past, when the economy was thriving, finding qualified employees was quite challenging. I'm curious if you see an opportunity to gain a competitive edge compared to your peers and how you might approach human resource opportunities as we recover from this downturn.

That's an interesting question. It's definitely something we're considering. However, our priority is to bring back the many employees who have been furloughed and ensure they can return to full weeks and hours. Once we achieve that, we will explore the possibility of hiring additional staff. You're correct that this situation presents us with opportunities to attract quality talent.

Our next question comes from Fredric Bastien.

I apologize if you've covered this already, but I also waited to get on the call and missed all your prepared comments. What kind of signals are you getting from clients and customers right now? Are they all saying they want you back once the restrictions are lifted? Or are you starting to see some hesitation on their part?

I don't think there's any hesitation, but we are definitely updating our service delivery protocols. Before we resume operations, particularly in residential homes but applicable to all areas, we will ensure clear communication with customers about our standard operating procedures and new protocols in the current environment. We are actively working on these revisions and must prepare our installation teams and painting crews for a new process that guarantees their safety as well as that of our customers.

Your next question comes from Matt Logan.

Can you discuss your willingness to invest capital over the next two or three quarters in relation to M&A? Would you say this is currently on hold? Is there a limit, or are you primarily considering distressed opportunities in the near term?

We are not focusing on distressed opportunities unless they align strategically. We have clear priorities for our acquisition strategy, and we are definitely not pausing our efforts. If we identify one of our high priority targets, we will seek to engage and complete the acquisition.

And maybe just changing gears. Would you be able to provide any metrics around the quantum of savings from furloughs and operating expense reductions?

Yes, I can give you a few numbers, and then I'll pass it over to Jeremy. But about 3,200 people in total have been furloughed or had their hours reduced. Over 500 with salary cuts, and on average significant cuts. And then a number of terminations. And Jerry, maybe if you want to provide dollars, I'll pass it to you.

Yes, sure. Matt, in terms of annualized impact, roughly, on personnel, cost reductions around $40 million, and then we've got some other stuff, T&E, marketing, other things where we're cutting to. That's on an annualized basis. Obviously, we're going to flex and see how long this plays out. That could be reduced. Furloughs, for example, we've got potentially people that we'll bring back in 90 days, call it, if we see an uptick in activity.

Appreciate the commentary. Maybe just providing a bit of a base for 2019 as we think about going forward, would you be able to tell us the 2019 and trailing 12-month adjusted EBITDA, if you had owned Global Restoration for the full period.

Well, when we do our leverage ratios, if I understand your question correctly, Matt, the 2.4x now includes the impact of Global for the period that we've owned it. And we get a 12-month window on all of our acquisitions. So we acquired this at the end of June. So there would be another quarter of Global built into that 2.4x leverage. Is that your question?

Yes. So I guess if I just take your debt and multiply that by 2.4, that would give me the related EBITDA if you'd owned Global for the full year.

Correct. Plus the other tuck-unders, correct.

Plus the tuck-unders. And I guess last one for me before I turn the floor back. When we look out to 2021 and 2022, can you give us any insights from the GFC in terms of what your experience was then? And if there's any read-throughs that you think might be relevant for investors in the current environment?

Scott here. I don't know where to start on that. This is so different. So I'm going to pass.

And there are no further questions at this time.

Okay. Well, listen, thank you for joining us today. I wish you all good health in the coming months. And we look forward to updating you in late July on our Q2 call.

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