Earnings Call Transcript - FSV Q1 2023

Operator, Operator

Welcome to the FirstService Corporation 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 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 Wednesday, April 26, 2023. I would like to turn the call over to Chief Executive Officer, Mr. Scott Patterson. Please go ahead, sir.

Scott Patterson, CEO

Thank you, Shannon. Good morning, and welcome, everyone, to our Q1 conference call. Thank you for joining. As usual, Jeremy Rakusin is on the line with me today. And together, we will walk you through the results we released this morning, results that reflect continued very strong growth in both divisions. Total revenues for the quarter were up 22% over the prior year with organic revenue growth at 17%. Again, this quarter was boosted by particularly strong growth in our Brands division. EBITDA was up 32%, reflecting a margin of 8.1%, a 60 basis point increase over last year's Q1, primarily resulting from operating leverage in brands. Earnings per share were up 16%. We're very pleased with our performance to start the year and confident that it sets us up for a strong 2023. I'll summarize our results for each division and then pass it over to Jeremy to provide more financial detail. At FirstService Residential, revenues were up 13% with organic growth at a very strong 11%. The organic growth reflects net new contract wins and increases in labor and services provided to existing accounts. We entered this year with momentum off the back of strong sales in the fourth quarter and solid client retention. Our growth was broad-based across North America, with particularly strong results in the Southeast and Texas, driven by wins in our high-rise and lifestyle verticals. And speaking of high-rise, at the end of March, we were very pleased to close on the acquisition of CrossBridge condominium services, the largest condo management company in the greater Toronto market. Together, we are now the clear leader in the fastest-growing high-rise condo market in North America. Sandro Zuliani and Tracy Gregory have led CrossBridge for many years, and we are delighted that they are partnering with us and will continue to lead day-to-day operations. Looking forward to Q2 and the balance of the year, we expect to show similar low double-digit top line growth for FirstService Residential with organic growth likely settling in at a high single-digit level. Moving on to FirstService Brands. Revenues for the quarter were up 30%, with organic growth at 23%, driven by very strong results at our restoration brands and Century Fire. Our restoration brands, Paul Davis and FirstOnSite, together recorded revenues that were up about 40% over the prior year, with almost three-quarters of the growth coming organically. We generated $75 million to $85 million from named storms during the quarter, including Hurricanes Fiona and Ian and Winter Storm Alliant. Sequentially, it's a similar level to the revenues generated in Q4 and significantly higher than storm-related revenues in Q1 of last year. Winter Storm Elliot impacted a very wide geography. It's difficult to nail down revenues directly relating to the event, which is why we have the range this quarter of storm-related revenue. During the quarter, we were excited to expand our Paul Davis company-owned platform with the acquisition of one of our largest franchises with operations in Houston, Raleigh, North Carolina, and Nashville, Tennessee. We're partnering with Bob Hillier across these three major markets. And together, we have ambitious growth plans. The Paul Davis brand has significant opportunity in these markets. Looking forward in restoration, we expect another strong quarter upcoming. Our backlog remains solid. It's up significantly over prior year levels, which will lead to strong year-over-year growth in Q2. Including the impact of recent acquisitions, we expect to show growth in Q2 of about 40% relative to a weak quarter for us in 2022 that was light on storm-related revenue. The back half of this year is difficult to forecast at this point. We expect to have some hurricane-related backlog that carries into Q3, but it is too early to quantify. In general, activity levels are strong for our restoration brands, and we feel very good about our market penetration and positioning relative to our competition. Moving now to Century Fire. We had another very strong quarter with organic revenue growth around 20%. I said in my prepared comments at year-end that Century has momentum across all its service lines, and that's what we saw during the quarter. Alarm and sprinkler installation, inspections and repairs, and national accounts are all up organically by double-digit percentages. The backlog at Century is stable, and bid activity remains solid, and we expect continued strong results over the balance of the year, albeit against tougher comps. We expect double-digit organic growth but not at the same elevated level as the last two quarters. And now on to our home service brands, which, as a group, were up close to 10% over the prior year, with organic growth accounting for about two-thirds of the lift. We're pleased with this performance in an increasingly uncertain environment. Leads are down at our home service brands as homeowners pare back or delay projects due to higher interest rates and the threat of a recession. Our teams remain confident that we will continue to drive growth this year. I said it before, the markets are huge, and the work is there even in a flat to down home improvement environment. Let me now call on Jeremy to review our results in detail.

Jeremy Rakusin, CFO

Thank you, Scott. Good morning, everyone. I'll start by summarizing our first quarter results on a consolidated basis, which in broad-based terms largely resembled our prior Q4 reporting period, with a common theme being very strong organic growth across the board, with the incremental revenue performance driving margin improvement and superior operating earnings growth. For the quarter, we reported revenues of $1.02 billion, a 22% increase compared to $835 million for Q1 ‘22. Adjusted EBITDA was $82.1 million, up 32% versus the prior year's $62.3 million, and this yielded an 8.1% margin for the quarter, compared to a margin of 7.5% in the prior year quarter. Our adjusted EPS was $0.85, up over the $0.73 per share in the prior year. We delivered this strong 16% year-over-year earnings per share growth even in the face of higher interest costs, which have more than doubled compared to Q1 ‘22. Our adjustments to operating earnings and GAAP EPS in arriving at adjusted EBITDA and adjusted EPS, respectively, are consistent with our approach in prior periods. I'll now summarize the segment results for our two divisions. FirstService Residential generated revenues of $446 million, up 13% over last year's first quarter, while EBITDA was $32 million, a 5% increase over the prior year. The EBITDA margin for the division came in at 7.2%, down 50 basis points versus the 7.7% margin last year. The margin was impacted by a higher mix of low-margin labor-driven services, which grew significantly as we both won new contracts and increased the penetration of existing accounts. During the seasonal trough Q1 period for a portion of our amenity management offering, this ramp-up of labor without associated revenue accentuated the margin impact. For the coming second quarter, we expect our residential margin to be roughly in line or mildly lower than the prior year period. Shifting to our FirstService Brands division, we reported revenues of $573 million during the first quarter, up 30% over last year's first quarter. EBITDA came in at $54.8 million, a 52% increase versus the prior year quarter. The division margin increased to 9.6%, up 140 basis points compared to last year's 8.2% level. On our last earnings call, we forecasted the margin improvement driven primarily by our restoration operations, which capitalized on weather-related storm activity during the current quarter compared against the mild weather patterns last year. For upcoming Q2, we anticipate brands margin improvement on the back of a similar sequential contribution from our restoration operations at the current quarter. Turning to our consolidated cash flow, we generated $63 million of cash flow from operations before working capital changes, up 24% over last year's first quarter. Working capital investments absorbed this operating cash flow, as is relatively typical during our seasonal trough Q1 when some of our businesses ramp up operations for the balance of your peak cash flow periods. These working capital requirements also included a significant increase in accounts receivable at our restoration operations due to the storm-driven activity over the past couple of quarters. This AR increase reflected a more than $70 million swing versus Q1 ‘22, which lacked any meaningful weather activity. Capital expenditures during the quarter were just over $20 million, up modestly year-over-year. We maintain our CapEx guidance for the year of roughly $100 million and $80 million on a normalized basis, excluding one-time office moves described in our prior Q4 call. Finally, during the quarter, we deployed approximately $80 million of capital towards three tuck-under acquisitions, which were a little larger than our typical size tuck-ins. We continue to be active in cultivating our deal pipeline as we look to be assertive in the current environment. Finally, our balance sheet. With the cash flow commentary I just provided, we closed the quarter with net debt of just over $700 million, resulting in leverage as measured by net debt to trailing 12 months EBITDA at 1.8 times. Liquidity, including our cash and undrawn bank revolver balance, is approximately $380 million. Our leverage is conservative and liquidity ample to achieve our growth targets. Looking forward, our outlook for the full year is relatively consistent with the high-level indicators I provided with our 2022 year-end results in February. We see the previous 10% annual revenue growth target ticking up to the low teens percentage range for three reasons: one, strong Q1 performance; two, restoration backlog conversion driving incremental revenue in Q2; and three, recent tuck-under acquisition contributions. We maintain our view that consolidated margins will be relatively in line or possibly slightly higher versus the prior year. That concludes our prepared comments. Shannon, you can now open up the call to questions. Thank you.

Operator, Operator

Thank you. Our first question comes from Michael Doumet with Scotia Bank. Your line is now open.

Michael Doumet, Analyst

Hey, good morning, guys. Very impressive quarter. Nice to see the organic growth. First question on FSR. I appreciate that raising prices in residential is always a challenge. But given the lower margins, I'm assuming in part due to the mix but also the lower retail activity. I wonder if the thinking with you and maybe some of your peers here is that prices need to continue to trend higher to offset some of these pressures and build back towards historical margins? And maybe to expand on that, are you seeing any increase in churn? And if not, can we assume that the 2% to 3% could continue for several quarters potentially?

Scott Patterson, CEO

Yes, I believe we are making progress. Our 11% organic growth includes approximately 3% from price increases. We are working towards returning to our historical margins. In this industry, we cannot immediately recover our cost increases due to competitive pressures. Therefore, we are consistently balancing margin with organic growth, and this will remain the case. However, we are confident that our margins will return to historical levels. It's important to note that transfer and disclosure income, which is a high-margin component, is still significantly below historical levels. We cannot raise prices on core management or other services to offset P&D costs, as those will also revert to their historical averages.

Michael Doumet, Analyst

Got it. That's really helpful. Thanks for the color. The second question, I think you get asked a version of this question every conference call, so in keeping with the tradition. Just on home improvement, if I look back through 2019, it looks like the cumulative growth ’22, ’21, in particular, was about 50%. Rates are growing slowing, and obviously, there are concerns. But I guess just to get a better sense for the sustainability of the last two years. Any way you can break down price and market share, just to give us a sense for how much those contributed to that growth?

Scott Patterson, CEO

Well, in that business, we have been able to pass along cost increases. So the last couple of years have been very strong organic growth years, 20% plus. We were probably close to half of that, maybe high-single-digit in price. In terms of sustaining growth in this market, the thesis and strategy is that we have leadership positions, but very modest share. These markets are huge. There is an opportunity for us to grow even in a down environment. That's certainly the belief system within our teams, and that's the situation we're in now. As I said in my prepared comments, our teams are very confident we'll grow this year.

Michael Doumet, Analyst

Got it. And maybe just as a follow-up. If I presume that promotional activity is picking up, any implications for margins?

Scott Patterson, CEO

Did you say promotional activity?

Michael Doumet, Analyst

Promotional activity, either increasing marketing or commercial?

Scott Patterson, CEO

Yes. No, that's actually very true. Headwinds are stronger in this business than they were at year-end, and we're definitely seeing consumers defer decisions and cut back on job size. For us, we see it as an opportunity to take share, take more share. We are investing in marketing and promotion, and that will temper any operating leverage that we might have otherwise seen with increased revenues. Additionally, it changes the dynamic for price increases. We'll probably see stable pricing this year, if not a bit of discounting.

Michael Doumet, Analyst

Got it. Makes sense. Thanks a lot, guys.

Operator, Operator

Thank you. Our next question comes from the line of Daryl Young with TD Securities. Your line is now open.

Daryl Young, Analyst

Hey, good morning, guys, and congrats on the good results. Just following up on the residential property management side. If you strip out that 3% price growth, you're still delivering huge market share wins and volume growth. Is there anything that's changed in the market that's allowing you to perform so strongly? I'm just wondering if maybe there's an increase in HLA outsourcing or if there's something following the pandemic where boards are more inclined to go with professional services or any color you can give there as very strong.

Scott Patterson, CEO

No, I don't think anything fundamental like that, Daryl. We had a very strong sales quarter in Q4 and solid retention, which gave us some momentum coming into Q1, which certainly helped. We will focus on continuing to drive that balance between wins and losses. The other modest boost we had in the quarter was increased labor and services at existing large communities in some regions, particularly our South region, where we have cost-plus contracts that specify a certain number of employees on-site. We've been challenged through the pandemic over the last few years to fill all of these contracted positions due to labor shortages, but in the last year, we have significantly reduced our open positions. In a cost-plus environment, that drives revenues. We expect to see some of that over the next few quarters as well, but it is not something that we will see ongoing.

Daryl Young, Analyst

Got it. Okay. And then just with respect to the investments being made in the restoration platform and the spend that's ongoing there. Can you give us any updates on how far along you are? I know you mentioned it's going to continue across this year. But are there any benchmarks or indications you can give us on when that drag may subside?

Scott Patterson, CEO

Jeremy, do you want to grab that?

Jeremy Rakusin, CFO

Sure. Thanks, Scott. Daryl, one of the major initiatives is onboarding our branches onto our operating platform that we've built out. It's largely technology-driven, and I'd say we're approaching the halfway mark on that. We've got over 100 branches that we need to get onto the single platform. So I've said before, we're going to be into '24 before we complete that, and then there will obviously be additional small modules on the edges, and we'll continue to optimize. But it's into '24, and we should be largely done with the major wave of these investments.

Daryl Young, Analyst

Got it. Okay. I’ll jump in the queue. Thanks, guys.

Operator, Operator

Thank you. Our next question comes from the line of Stephen MacLeod with BMO Capital Markets. Your line is open.

Stephen MacLeod, Analyst

Oh, great. Thank you. Good morning, everyone. I just wanted to follow up on the residential business. I know you mentioned that organic growth was quite strong. I'm curious if a lot of those gains are coming from market share increases. If that's the case, is it just the usual attrition in the market, or is there something more happening that makes you more competitive and drives those above-average organic growth rates?

Scott Patterson, CEO

Yes. We continue to have success in high-rise and large lifestyle communities where we have scale and expertise, and we're seen as experts. These are large communities, often with 100 plus people on-site. These are staff members that need to be recruited, onboarded, trained, and managed, which is complex. They also require a broad service offering, including food and beverage, amenity management, event planning, and so on. Our expertise in this area is well known, and it's less competitive for us. Therefore, we have certainly a greater win rate when we have opportunities in front of us like this. This is a sweet spot for us, and it's a focus of ours. I think it's primarily those verticals, Stephen.

Stephen MacLeod, Analyst

I see. Okay. That's interesting. And would you characterize the runway for those incremental contract gains in those verticals, high-rise, and large lifestyle communities, as a large addressable market? Or is that sort of more of a niche segment of the market?

Scott Patterson, CEO

No. It's large. This has been a significant component of our growth for many years. I think the 11% boost is largely from filling open positions and price; we're not far off our historical rate when you take those into account.

Stephen MacLeod, Analyst

Okay, I see. That's helpful. Thanks a lot. And then just on the brands business. Jeremy, you talked a little bit about the margin expectation for Q2. Just curious, would you expect or maybe it's too soon to say, would you expect to see a similar type of margin gain in Q2? And then secondly, I guess, on the back of what was a strong Q1 margin and what's expected to be ongoing margin strength in Q2, do you feel like you're well-positioned to drive margin growth in the brands business on a full-year basis?

Jeremy Rakusin, CFO

For Q2, I can't say for certain if it will reach 140 basis points, but we will definitely see significant margin improvement, mainly due to a consistent contribution from restoration like we experienced in Q1, which was similar to Q4. We’re seeing three comparable quarters of additional revenue from restoration driven by weather and daily gains, which will enhance our consolidated margin. Looking to the second half of the year, we need to be careful. It's not solely about restoration; other business areas play a role too. However, restoration's performance will particularly hinge on the weather in the latter half of this year. In Q3, if we compare it to last year, there wasn't much to note, so it could be a straightforward comparison if we don't get favorable weather. For Q4, we had strong results in 2022, and our performance will depend largely on weather conditions for that sector. All other business segments are doing very well in terms of margin.

Stephen MacLeod, Analyst

Okay, great. That’s it from me. Thanks, guys.

Operator, Operator

Thank you. Our next question comes from Stephen Sheldon with William Blair. Your line is now open.

Stephen Sheldon, Analyst

Hey, good morning. Congrats on the results. First question here on Century Fire. I know there are some concerns about construction activity slowing here given the macro challenges. So curious how you're thinking about the risk of slowing construction activity weighing on the growth trajectory of the fire business over the next few years, just given that new construction is at least one factor supporting growth there?

Scott Patterson, CEO

Yes, certainly, Stephen, we're keeping an eye on our bid activity and backlog. Our backlog is in a position that gives us visibility really for the balance of the year, and we feel comfortable with the balance of the year. As you suggest, the headwinds in the home improvement market and often residential is a precursor to commercial. So we're very cognizant of that. I would say in this last quarter, service, in particular, led the way for us in terms of growth. We feel very good about that. We continue to focus on that balance between new construction, service repair, and national accounts. It's a fair point.

Stephen Sheldon, Analyst

Got it. And then this is a question I've asked before regarding restoration, but how do you think about the strategic benefit of having scale on both the residential and commercial side of restoration? Specifically, has that benefit changed at all or become even more important, especially in times like this where there's a lot of work and storm-related work where you can allocate labor resources more dynamically? Just any updated thoughts on that?

Scott Patterson, CEO

Well, scale in commercial and residential independent of each other is very important as our national commercial occupiers, owners, and managers look to consolidate their vendors. So it matters; having a branch network matters, and certainly in residential, it matters. Paul Davis, with 330 locations, is positioned well with national insurance carriers. Together, we're not necessarily collaborating in terms of workforces, but there are lots of referral work back and forth, and joint efforts in terms of presenting and positioning ourselves with insurance companies to be the residential and commercial solution. We won a couple of accounts together. That's really the big opportunity: referrals and working together with insurance companies.

Stephen Sheldon, Analyst

Great. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Frederic Bastien with Raymond James. Your line is now open.

Frederic Bastien, Analyst

Good morning, guys.

Jeremy Rakusin, CFO

Good morning.

Frederic Bastien, Analyst

So you made your two largest deals in the past five, six years or so when credit tightened and private equity paused, and we're certainly seeing this kind of dynamic currently. In light of this, can you please tell us how on a scale of zero to ten, how excited you are about your pipeline of M&A opportunities, whether that's large deals or more tuck-in opportunities?

Scott Patterson, CEO

Well, the pipeline is solid, Frederic. I don't want to temper your excitement, but we have a number of tuck under transactions in process, and they are our typical type of tuck-under deals, small family-owned businesses. We're pleased with the deals we've announced this year at Paul Davis and FirstService Residential, and our activity levels are balanced, but certainly nothing significant in the works. As Jeremy said in his prepared comments, we have a conservative balance sheet. We have a significant amount of liquidity available to us. Like you, we believe that this is an opportune environment for us, and we're ready for an opportunity if we have a shot.

Frederic Bastien, Analyst

Thanks, Scott. That’s all I have. Thank you.

Operator, Operator

Thank you. I'm showing no further questions at this time. I would now like to turn the call back over to Mr. Scott Patterson for closing remarks.

Scott Patterson, CEO

Thank you, Shannon, and thank you, everyone, for joining this morning. We look forward to our Q2 call. Have a great day.

Operator, Operator

Ladies and gentlemen, this concludes the FirstService Corporation First Quarter Investors Conference Call. Thank you for your participation, and have a nice day.