Earnings Call Transcript - FSV Q3 2021

Operator, Operator

Welcome to the Third Quarter Investors Conference Call. Today's call is being recorded. Legal counsel requires us to advise that the discussion scheduled to take place today may contain forward-looking statements that involve known and unknown risks and uncertainties. Actual results may be materially different from any future results, performance or achievements contemplated in the forward-looking statements. Additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statements is contained in the company's annual information form as filed with the Canadian Securities Administrators and in the company's Annual Report on Form 40-F as filed with the U.S. Securities and Exchange Commission. As a reminder, today's call is being recorded. Today is Tuesday, October 26, 2021. I would now like to turn the call over to Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

Scott Patterson, CEO

Thank you, Phyllis. Good morning, everyone, and thank you for joining our third-quarter conference call. Jeremy Rakusin, CFO, is on the line with me today. I will start us off with a summary of our performance growth drivers and highlights for the quarter, and Jeremy will follow with a more detailed look at the financial results. Let me start by saying we are very pleased with the results for the quarter, which reflect continued strong organic growth despite a very tough labor environment, lingering COVID challenges, and supply chain obstacles. Jeremy and I together will touch on these challenges in more detail. Total revenues for the quarter were up 14% over the prior year, with organic revenue growth at 8%. We again generated year-over-year organic growth across every platform with particular strength at FirstService Residential, Century Fire, and our home improvement brands. EBITDA for the quarter was $94 million, up 6% versus 2020, reflecting a margin of 11.1% compared to 12% in the prior year. Earnings per share were $1.50 compared to $1.19 last year. Jeremy will walk you through the year-over-year movement in the profitability metrics in his prepared comments. At FirstService Residential, revenues were up 13%, with organic growth at 8%. Again this quarter, a strong contributor to year-over-year organic growth was the reopening of seasonal pools and fitness centers in the Northeast U.S. and Canada. The reopening began in the second quarter, and by the end of the third quarter, about 90% of our managed facilities were open and staffed. Outside of amenity reopening, we generated mid-single digit organic growth, in line with our long-term expectations for this division. A highlight at FirstService Residential during the quarter was the acquisition of the condo management division of Atlantic Pacific, a leading high-rise management company in South Florida. Atlantic Pacific has a strong and experienced team that manages a marquee portfolio of about 100 communities. The acquisition extends our significant leadership position in Florida and, importantly, strengthens our operating team and deepens our talent pool with the addition of 900 associates. This is a great addition for us. We've long admired the team and the portfolio at Atlantic Pacific. Looking to the fourth quarter at FirstService Residential, we expect to show high single-digit revenue growth benefiting from the recent acquisition and amenity reopenings relative to the prior year. Moving on to FirstService brands, revenues for the quarter were up by 16%, 9% organically. Our Home Improvement segment was up by 15%, all organic. Sequentially relative to Q2, we were down slightly. The Home Improvement market continues to be strong, and we continue to generate record levels of leads and bookings. Our challenge in these brands has been our capacity and ability to produce the work. The resurgence of COVID during the quarter impacted many of our branches, compounding the capacity issue we've been dealing with all year due to the tight labor market. In addition, we were confronted with numerous supply chain issues during the quarter, which impacted our ability to complete work. All of the Home Improvement brands were faced with scheduling issues due to shipping delays and material shortages. So we were up 15% versus the prior year and 14% versus 2019, which reflects impressive growth, but we had the opportunity to do much better. The good news is that most of the deferred work remains in our pipeline. We're communicating extensively with our customers and rescheduling where we can for this quarter or for early 2022. Through alternative sourcing and other measures, we believe the supply chain issues are largely behind us, and we expect to show improved growth in the fourth quarter for our Home Improvement brands, north of 20%, which is where we expected to be this past quarter. Our restoration brands FirstOnSite and Paul Davis, together, were up over 10% relative to Q3 of last year with mid-single digit organic growth. This is a strong result, and we are thrilled to have generated organic growth in restoration against a tough comparative quarter for us last year that included about $45 million in revenues from the Iowa wind storms and Hurricane Laura. We benefited this past quarter again from the Texas storm where we closed our final jobs, and then hurricane Ida, which impacted Louisiana, New Jersey, and New York in late August and early September. We generated about $30 million during the quarter from these events. Excluding the storms, organic growth was low double-digit, which is a positive reflection on our momentum in growing day-to-day business by signing new customers and gaining incremental share of existing accounts. We were excited during the quarter to expand our footprint at FirstOnSite with the acquisitions of Complete DKI in the Florida Panhandle region, More Restoration in Central Indiana, and Insurance Restoration Specialists serving New Jersey and Metro Philadelphia. These acquisitions are in areas that are regularly impacted by weather events. Each is an important strategic addition that enhances our ability to respond to our national commercial accounts and brings on strong leadership and talent that we're excited and proud to have on our team. We continue to carry a solid backlog at our restoration brands and expect that to drive a strong fourth quarter that we'll get close to our fourth quarter from 2020, which was outside with $60 million of work from the 2020 weather event. Century Fire again grew by double digits this quarter, buoyed by a solid commercial construction market and strong momentum with our national account service and repair program. Backlogs and bid activity remained strong, and we expect to see near double-digit year-over-year growth in Q4. Before I hand off to Jeremy, I want to emphasize how pleased we are with the continued momentum in organic growth, 8% on a consolidated basis, with strong organic growth at each service line. It's a great reflection on our teams and their ability to win in the market day-to-day.

Jeremy Rakusin, CFO

Thank you, Scott. Good morning, everyone. Our third quarter financial performance, as you just heard, was driven by strong organic and overall revenue growth and very balanced across both of our divisions FirstService Residential and FirstService Brands. I will provide segmented commentary in just a moment, but first a consolidated recap. For the third quarter, FirstService total revenues came in at $849 million, adjusted EBITDA at $94.2 million, and adjusted EPS at $1.50 up 14%, 6%, and 26% respectively. On a year-to-date basis, we have delivered strong consolidated results across the board, both in terms of top-line and profitability and with significant contributions from all of our operations within both divisions. Financial highlights for the nine months year-to-date include revenues of $2.39 billion, up from $2 billion even in the prior year period, an increase of 20%, which includes 13% organic growth. Adjusted EBITDA also increased 20% up to $243.8 million compared to the $203.8 million in the prior year third quarter, with our overall EBITDA margin remaining in line at 10.2%. Lastly, our adjusted EPS year-to-date currently sits at $3.36, up 38% over the $2.44 per share reported for the same period last year. Adjustments to operating earnings and GAAP EPS in providing adjusted EBITDA and adjusted EPS respectively are disclosed in this morning's earnings release and are consistent with our approach in the prior period. I'll now elaborate on our third quarter segmented results. Within our FirstService Residential division, we reported revenues of $423.1 million, a 13% increase over Q3 2020. This strong top-line performance growth EBITDA of $45.1 million is an 8% increase year-over-year. At the same time, we did see our EBITDA margin moderate by 50 basis points to come in at 10.7% for the quarter. This margin decline resulted from two factors. First, we have experienced, in general, an increase in wages across the division. We can recoup some of this through cost-plus contracts, but much of it will be subject to getting price increases through contract renewals. The second factor contributing to our margin for the quarter was the increased labor coming onstream to support our amenity facility reopenings during the quarter, which yielded a typical sub-10% fully burdened margin that averaged down the overall division margin. Now to our FirstService brand division, the division generated revenues of $426.4 million during the current third quarter, up 16% versus the prior year period, and supported by both the strong organic growth drivers that Scott commented on, as well as contributions from recent tuck-under acquisitions. During the current third quarter, our brands EBITDA came in at $53 million, a 9% increase year-over-year, with a resulting 12.4% margin down compared to 13.3% in last year's Q3. The margin decline was primarily attributable to supply chain constraints affecting the pricing of our raw material inputs at both our Home Improvement brand and Century Fire protection, as well as increased labor costs also related to those supply chain bottlenecks, which caused scheduling issues and inefficiencies within our frontline teams in completing jobs. Reverting now back to our consolidated results, just a couple more comments to note on our overall profitability. First, we incurred a $2 million year-over-year increase in corporate costs during the third quarter that impacted our overall EBITDA and operating earnings, reflecting a normalization of compensation expenses compared to the COVID-driven cost reductions in the prior year quarter. Our total corporate cost of $3.9 million during the quarter is consistent with my comments in Q2 regarding reversion back to an annualized corporate cost run rate in the mid-teens millions of dollars. Second, we realized a $12.5 million gain in other income related to the sale of our small non-core legacy pest control business based in Florida, which was part of our FirstService Residential division. On an after-tax basis, this divestiture contributed $0.21 to our adjusted earnings per share of $1.50 for the third quarter. In terms of capital deployment during the third quarter, we saw strong activity without tuck-under acquisition program. We invested $46 million during the period in four transactions that will bring approximately $75 million in incremental annualized revenues. Our deal pipeline remains quite active, as our teams continue to be engaged in varying stages of dialogue with prospective targets. We also incurred $13 million in capital expenditures during the third quarter. With year-to-date CapEx sitting at $42 million, we are on track with our $60 million full-year target. Cash flow was strong during the quarter, allowing us to internally fund a good portion of these capital requirements while at the same time incrementally strengthening our balance sheet further. Before working capital changes, cash flow from operations was $72 million, up in line with EBITDA growth over the prior year quarter. We realized almost $30 million of operating cash flow after working capital investments required to support both across-the-board strong organic growth of our existing businesses and the recent tuck-under acquisitions. Our balance sheet at quarter-end included net debt of $425 million, resulting in our leverage coming in at 1.2x net debt to trailing 12 months EBITDA, down sequentially from our prior second quarter. Our liquidity and debt capacity also remained strong, with approximately $535 million of total cash on hand and undrawn availability under our credit facility. To close off our prepared comments with an outlook, you have already heard Scott's top-line indicators for the fourth quarter for each of our businesses. On a consolidated basis, we therefore expect our revenue growth in Q4 to be in the high single digits. Our consolidated EBITDA margin in the fourth quarter will see some year-over-year decline, largely due to similar labor cost-driven margin dilution at FirstService Residential as we saw in the third quarter. On a full-year basis, we anticipate our consolidated EBITDA margin to come in at around 10%, relatively in line with 2020 and consistent with our expectations that we communicated on our second quarter earnings call. In terms of our 2022 outlook, we will provide some high-level color during our 2021 year-end earnings call scheduled for early February. That concludes our prepared comments. Phyllis, you can now open up the call to questions. Thank you.

George Doumet, Analyst

I did want to talk about the low double-digit organic growth and restoration excluding storm activity. That's the big number, I think, Scott, you alluded to that earlier. So can you give us a little bit of color on where that's coming from? And just wondering, I think the baseline for that previously was mid-single digits to high single digit, but just wondering how we should think of that kind of strength on a go-forward basis.

Scott Patterson, CEO

Sure, George. I mean, I think it's really executing on the growth plan and in particular, leveraging our branch network to better position ourselves with national accounts. Specifically, we're investing aggressively in our sales force. In each of the quarters this year, we've recruited high-level sales talent that have a number of established relationships. We're also building out our sales verticals and particularly focusing on high-end more complex customers, where we can differentiate ourselves. Examples would be healthcare and defense contractors, and chemical facilities where our teams need specialist training and certification, and it's enabled us to really build our verticals nationally. At the same time, our branch network is having real success winning local and regional business. So we are focused on building our day-to-day business relative to the industry. Our dependence on weather events, cat storms, is lower and strategically that's a goal for us.

George Doumet, Analyst

Okay. Thanks for that. Staying on this vertical, maybe switching gears to the M&A part of it. Is there ultimately a strategy or a game plan in terms of how big we want to get in this segment and which markets you'd like to have maybe a top presence in?

Scott Patterson, CEO

There is certainly a $60 billion market, and we rank second on the commercial side and second on the residential side with a relatively modest market share. This positions us to grow significantly compared to our current size. Strategically, it’s important for us to establish a strong presence in all major markets and to serve national customers across North America, and we are actively working towards that goal.

George Doumet, Analyst

Okay. Just one last point, if I may, the residential segment, of the 70% of business that's not cost plus. Can you maybe explain how we adjust pricing and wages? I think Jeremy, you did call out a lot. Talk to us. Can you talk a little bit about that? And maybe how much of this quarter’s 8% organic growth was pricing versus volume? Should we expect those trends to continue? Thanks.

Jeremy Rakusin, CFO

Yes, sure. So just the back end of your question, George, most of it's volume. I mean, in this industry, pricing is very modest. It's historically been about a percent, percent-and-a-half. That's no different. So in terms of dealing with the non-pass-through cost-plus components, we believe that we're going to capture some of that wage inflation back through price increases as contracts renew. Those can be one-year or multi-year contracts. Continuing to work on operating efficiencies that have always been in progress over the last five, six years, and the teams are always working to extract some of those. Those two factors in combination will allow us to, again, recoup any margin impact due to wage inflation.

Scott Fromson, Analyst

In the Home Improvement brands, what are you seeing in terms of average ticket size? So kind of adjusted for recent inflation if you can, or maybe another way to put it is, are you seeing a change in demographics for your business?

Scott Patterson, CEO

I'm just digesting, Scott, in terms of a change in demographics. I think, certainly, millennials, we're focusing much more on the younger generations as they become homeowners and buyers of our services. I'm not sure I understood the first part of your question.

Scott Fromson, Analyst

Just, I guess it relates to organic growth. But basically on a per call basis, are you seeing that revenue per call go up? Or is that metric you even track?

Scott Patterson, CEO

No. It is. It certainly average job size is something we track, and we're seeing increases at each of our businesses. Some of that is price. We are more nimble in terms of increasing our price and responding to cost increases in the Home Improvement brands. There's still a lag because we're booked out two to three months. But certainly, with 15% growth this quarter, expecting 20 next quarter, most of that is volume, but there is some price. And at the same time, we are seeing consumers taking on and booking larger jobs, more ambitious renovation work. And so we're seeing that also.

Scott Fromson, Analyst

Thanks. That's exactly what I was looking for. And just on the residential business, you said 90% of residential facilities or amenities, I guess, are opened. What's the outlook for the remaining 10%?

Scott Patterson, CEO

Well, many of them that are open are seasonal. And so it'll be 2022. We do. We do.

Frederic Bastien, Analyst

Scott, you've been pretty upfront with us about your expectations for organic growth to return to the mid-single-digit rates for both FSR and FSB at some point. Certainly looks like we're going to be well above that in Q4, but how much visibility do you have beyond that and heading into 2022?

Scott Patterson, CEO

I think, for FirstService Residential, we expect that to settle back to low to mid-single digit organic growth. And then, the brands, there's some moving parts, Home Improvement, everything that we see points to continued strength through 2022. So that will be a tailwind for us, we expect. Century Fire continues to be strong. Then, restoration, we've just got the very tough comps going into '22 that we're going to be dealing with. So I feel good about the organic growth across the board. Honestly, I think '22 and brands, it really depends on restoration.

Frederic Bastien, Analyst

Okay, cool. Thanks for that. Now, if we just look at restoration and also get Century Fire, you've done a number of tuck-in acquisitions. I'm just wondering where your footprint resides now, with both sort of businesses and whether there are still some whitespace areas that you're looking at right now for growth.

Scott Patterson, CEO

We have significant opportunities ahead. Century Fire is primarily located in the Southeast U.S., with additional prospects in Texas and parts of Florida. This year, we have expanded into the mid-Atlantic through acquisitions, which presents many opportunities in that region. Similarly, in Restoration, we need to expand our presence in the Western U.S., and there are still growth opportunities in the South, particularly in the South Atlantic area where storm activity is higher, apart from Florida. So, Texas and the Southeast are key areas for us.

Frederic Bastien, Analyst

Great, thanks. Thanks, Scott. Next one for Jeremy. The rate of earnings that's attributable to the non-controlling interest is pretty hard for us to predict and model, but it seemed to have come a little lower than at least if it came in lower than we had forecasted. Is there anything unusual in the current quarter? Can you give us a sense of where that rate percentage will end up in the year?

Jeremy Rakusin, CFO

Yes, Frederic. Quarter-to-quarter it is hard, as you said, to forecast for you guys. It depends on the mix of our 100% owned businesses versus the partner businesses. But on a long-term or annual basis, I’d say 8% minority interest share earnings is a good number.

Stephen MacLeod, Analyst

Just had a couple of questions here on the labor inflation specifically. I assume is it safe to assume that labor inflation and labor availability would have impacted you more on the top line in brands versus residential? And if that's the case, is there any way to quantify sort of how much more you were held back because of some of the labor shortages?

Scott Patterson, CEO

The impact was felt across all our businesses, but it was likely more pronounced on the brand side, particularly in Home Improvement and, to some degree, in restoration. We still have a significant number of open positions, but it's hard to provide a specific quantification. We had anticipated that Home Improvement brands would increase by over 20%, but we only reached 15%. We believe we can recover that in the upcoming quarters as we address this work, but it's challenging to quantify due to the many variables involved.

Stephen MacLeod, Analyst

Okay. Yes, that's understandable. Then maybe when you think about labor inflation, on the residential side, presumably with your scale, you're well positioned to manage through these kinds of headwinds. Do you see an opportunity for accelerated new contract wins? Maybe as smaller competitors or contracts come up for renewal and they can't find the staffing or have the staffing to renew at a reasonable rate? That's something we could potentially see heading into 2022.

Scott Patterson, CEO

We're not expecting that. One of the issues is that competing with the smaller private companies, they compete with us on price. That's their approach to these accounts, and they're comfortable earning a lower margin; significantly lower in some cases. So I don't see the opportunity on the organic growth side, necessarily, no.

Stephen Sheldon, Analyst

First in the residential segment, another really strong quarter of organic growth there. Curious if looking at the segment by property type, if you're seeing any different growth trends, especially between mid- and high-rise condos versus other property types. Would you expect any mix shift in that portfolio as you think about the next year such as a revenue shift more towards mid- and high-rise condos as I think just looking back over the last few years, the mix has been it seemed to be pretty stable there? Just would love any color.

Scott Patterson, CEO

Yes. I think if there's a change in mix, Stephen, it's very subtle. But we are winning larger high-rise opportunities and large masterplan communities, lifestyle, new development. It requires a more complex service offering including event planning, lifestyle, and really a breadth of services that not many of our competitors have. So there is a subtle shift towards that type of property in our portfolio.

Scott Sheldon, Analyst

Got it. That's helpful. And then, just wanted to ask on going back to kind of the labor pressures across the organization and maybe the month-to-month cadence there. Did that pressure become even more pronounced throughout the quarter? Would you expect it to become an even bigger headwind to growth as you think about the rest of this year and into 2022?

Scott Patterson, CEO

It definitely intensified through the quarter and has over, I guess, I'm going to say the last five or six months; the competition for talent is fierce. For FirstService Residential, it comes really from hospitality and the reopening. On the brand side, it comes from construction and other home improvement companies. But what we've seen is we've seen our turnover increase at every business. I think we are making the decision internally to pay the people we know, the people we trust, the people that carry our values because we're seeing clearly that we'll need to pay that higher amount for someone new. I think we're maybe moving perhaps a little bit in front of others. We'll see it continue into the fourth quarter, but we're also making moves on the price side as contracts come up and there contracts do come up for renewal at the end of the year. We're not going to be able to, as Jeremy said, there's going to be a lag; we have multi-year contracts, and we're not getting it back immediately. But we will work our way through this.

Matt Logan, Analyst

Scott, you've provided some really good commentary on the restoration business earlier on the call. I know you don't have a formal five-year plan. But would you mind taking a few minutes to talk about how you see the business evolving through 2025? Any color on things like expected growth rates, the overall mix by division, and maybe some updates for your other branded businesses would be appreciated?

Scott Patterson, CEO

It's like all our businesses, Matt, we are an organic growth company first, and that's our focus. So we're doing all the hard work necessary to drive that over the long term, and aspirationally, we want FirstOnSite and Paul Davis to be iconic brands. We're doing more of that foundational work at FirstOnSite right now with the operating platform and investing in it, and recruiting to drive it. I talked about recruiting sales teams and building out our branch network. This is all around long-term organic growth. For each of our businesses, we target mid-single-digit growth on average over time, and then we look to enhance that through acquisition. There's very active consolidation in restoration right now. You've seen us be active; we will continue that. The acquisitions won't continue at the same pace. We'll be driving the organic growth. In terms of getting out to 2025, we're looking beyond that, and we will be a leader in this business on both the commercial side and aspirationally on the residential side too, but that's a long-term view.

Matt Logan, Analyst

Do you think there's any whitespace in your businesses outside of where you're at today, property-related services that aren't restoration or clauses or home inspections or things that you see opportunities that might be a potential vertical?

Scott Patterson, CEO

Yes. There are opportunities that are tangential, I would say. Tangential to restoration, perhaps tangential to something FirstService Residential. You think about storm damage and weather events and restoration in general and everything that goes into that. We provide some of those services, and there's opportunities to increase the breadth of services that we provide. FirstService Residential, you think about all the staff and services provided to buildings and where we can expand. We’re always thinking about those things. I don't know that it's necessarily a new vertical as much as expanding the services that we provide to our existing customers.

Matt Logan, Analyst

Okay. And maybe just one housekeeping item for me, if you don't mind changing gears. In terms of the storm revenue this quarter, it was about $30 million, if I have my numbers right. What was that on an EBITDA basis?

Jeremy Rakusin, CFO

Would have been pretty similar as is typical in some of the other quarters, Matt, around 10%, which is how FirstOnSite has performed over the last six-plus quarters.

Operator, Operator

And at this time, there are no further questions.

Scott Patterson, CEO

Thank you, Phyllis. And thank you, everyone, for joining. We look forward to our year-end call in February.

Operator, Operator

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