Earnings Call Transcript - FSV Q2 2021

Operator, Operator

Welcome to the Second 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 July 27, 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, Branna and good morning, everyone. Welcome to our second quarter conference call. Thank you for joining us today. I'm on the line with Jeremy Rakusin and together, we will walk you through the quarterly results we released this morning. Those reflected very strong growth over the second quarter of 2020, which of course was the first quarter materially impacted by the pandemic. Total revenue for the quarter was up 34% over the prior year, with organic revenue growth at 25%. Organic growth was strong at both divisions and at every material business line across the board. It reflects three main drivers: the reopening of seasonal amenities, very strong home improvement spending, and continued work from the Texas deep freeze event in February of this year. Organic growth was 25% versus a depressed 2020, due to the COVID lockdowns versus 2019, organic growth was 10%. That figure does not include FirstOnSite, which we did not own at that time. The organic growth exceeded our expectation and in particular was impressive given the current labor market. The number of open positions we have across the company is unprecedented and it definitely limited our capacity and tempered our growth. The balance of the top line growth for the quarter, 9%, was from tuck-under acquisitions over the last year in restoration, fire protection and property management. EBITDA was up 26% year-over-year, and earnings per share were $1.21, up 41% over the prior year. Jeremy will provide more detail on these metrics in his prepared comments. At FirstService Residential, revenues were up 20% with organic growth at 16%. The principal driver of organic growth was the reopening of seasonal pools, fitness centers and other amenities in the Northeast U.S. and Canada. The reopening accelerated quickly through the quarter and by quarter-end approximately 90% of our managed facilities were open and staffed. We will see some additional reopening in the third quarter and expect to be back close to 100% by year end. There are a small number of seasonal pools that will not open this year, but the impact is not material to our results. Outside of amenity reopening, we generated solid organic growth driven by contract wins and gains in ancillary services. Relative to the second quarter of 2019, the FirstService Residential division was up 9% organically. Looking forward to the balance of the year, we will see some incremental year-over-year benefit in the third quarter from seasonal amenity reopening. In the fourth quarter and into 2022, we expect to settle back into a low-to-mid single-digit average organic growth rate in this division. Moving on to FirstService Brands, revenues for the quarter were up by 50% versus 2020, driven by strong growth in our home improvement segment and continued strong results from our restoration brands. Our home improvement brands, California Closets, CertaPro Painters, Floor Coverings International and Pillar To Post were up as a group by over 50% versus the prior year quarter, a period during which much of North America was in lockdown. A more relevant and impressive metric is the 25% growth for this group relative to the second quarter of 2019. Very strong existing home sales in combination with continuing increases in prices and home equity have further buoyed an already strong home improvement market. Vaccine rollouts and the release of pent-up demand in certain regions has added to the activity levels. Our brands have benefited from the strong market and leads, bookings and completed jobs are at all-time highs. We reported last quarter that our challenge was production capacity to meet the demand. It remains a significant limiter for us. However, we made headway during the quarter as evidenced by the sequential revenue increase of 16% relative to our Q1. Some of this increase relates to seasonality, but much of it is tied to an increase in production capacity. We continue to recruit aggressively and believe this will be reflected in a further sequential increase in Q3 for our home improvement brands. On a year-over-year basis for Q3 and Q4, we expect to see growth in excess of 20%. Our restoration brands, FIRST ONSITE and Paul Davis, together were up over 50% relative to Q2 of last year. FIRST ONSITE is the big driver corporately for us, because it is all company-owned, while Paul Davis is primarily a franchise system. The organic growth this quarter was again driven largely by the deep freeze weather event in February of this year that impacted Texas and Oklahoma. We carried a significant backlog into the quarter and completed and booked approximately $50 million of revenue related to the event. Organic growth outside of this event was low double-digit, reflecting continued progress at both FIRST ONSITE and Paul Davis in terms of adding national customers and building the brands. Our backlog and restoration remains strong heading into the back half of the year, but we are up against very strong comparative results in 2020. You will remember that we secured significant work last year from the Iowa windstorms and Hurricane Laura. Across the third and fourth quarter, we generated over $100 million of revenue from these events. Our goal is to at least match the 2020 results, which would mean a very strong growth year for us in restoration. For that to occur, we would again need to generate work from extraordinary weather events. Century Fire was up low double-digits versus Q2 of 2020 and generally in line with our expectation. Both the service and installation sides of the business contributed to the quarterly growth. Backlogs and bid activity remain strong heading into Q3 and we expect a solid back half of the year for Century Fire with similar year-over-year growth to Q2. Before I hand off to Jeremy, I want to reiterate how pleased we are with the overall results for Q2 and particularly the organic growth we generated at each of our service lines. We continue to focus on building our brands over the long term and have confidence that our business model and long-term growth prospects remain intact. Over to you, Jeremy.

Jeremy Rakusin, CFO

Thank you, Scott, and good morning everyone. As you just heard, we reported strong financial results for the second quarter, with both significant growth over last year and our performance relative to our internal expectations. I will provide a segment breakdown momentarily, but let me first reiterate our Q2 consolidated results. Revenues were $832 million, adjusted EBITDA was $89.8 million and adjusted EPS came in at $1.21, up 34%, 26% and 41%, respectively. Combined with our first quarter results, our six months year-to-date consolidated financial performance is as follows: Revenues of $1.54 billion, an increase of 23% over the $1.26 billion last year. Adjusted EBITDA of $149.6 million, representing 30% growth over the $115.1 million last year, with a margin of 9.7%, up from the 9.2% in the prior year period. Adjusted EPS at $1.87, up 52% versus $1.23 per share reported during our same 6-month period last year. Our adjustments to operating earnings and GAAP EPS to calculate our adjusted EBITDA and adjusted EPS, respectively, have been summarized in this morning's press release and remain consistent with our disclosure in prior periods. Turning to our segments and financial result highlights for Q2, I'll lead off with our FirstService Residential division. Second quarter revenues came in at $406 million, a 20% increase over the prior year period. We were pleased with this year-over-year growth given the comparison to last year's quarter, which itself was only down less than 10% in the eye of the pandemic. EBITDA for the quarter was $46.5 million, a 25% year-over-year increase, with an 11.4% margin up 40 basis points from the 11% margin in Q2 of last year. The margin improvement benefited once again from higher margin transfers and disclosures revenue, driven by very strong unit resales within our communities compared to last year's second quarter. This heightened level of home resale activity reflects a continuing theme that started in the second half of 2020, and so we would not expect any further meaningful margin pickup at FirstService Residential from this ancillary revenue in the back half of this year. Now on to our FirstService Brands division. In the second quarter, we recorded revenues of $425 million, a 50% increase over the prior year period. EBITDA for the brands segment during the quarter came in at $48.2 million, up 34% year-over-year and yielding an 11.3% margin down from the 12.6% margin in last year's Q2. There were two principal reasons for this margin compression during the quarter. First, as we indicated with our outlook for this quarter during our prior Q1 call, the increased contribution from our restoration operations in the second quarter, relative to our home improvement brands diluted the division margin. Second, the margin level reflects reinvestment, including headcount additions for growth by most of our brands relative to last year's Q2, when aggressive COVID-related cost cutting initiatives were incurred. On a consolidated basis, our EBITDA margin for the second quarter came in at 10.8%, down 70 basis points from the 11.5% last year. This margin dilution resulted from higher corporate costs, which totaled $4.8 million this quarter, up $3 million from last year's Q2, when significant pandemic-driven head office compensation and other expense reductions were implemented. Excluding the impact of these higher corporate costs, our combined EBITDA margin from our two operating divisions was approximately flat to the prior year quarter. We expect to see our full year 2021 consolidated EBITDA margin end up relatively in line with last year's 10% level. Shifting to our operating cash flow, before the impact of working capital changes, we were up 35% for the quarter, mirroring our strong revenue and EBITDA growth. Cash flow from operations after working capital, however, was down versus Q2 2020, due to a significant working capital swing related to higher accounts receivable balances at FirstOnsite Restoration, reflective of their strong activity levels and Texas freeze work. This quarter's growth investment also contrasts with last year, when our efforts were focused around cash preservation and collections in the face of the initial pandemic uncertainty. With respect to our capital spending, just over $15 million was earmarked towards internal growth in support of our operations. This keeps us on track with our $60 million full year CapEx target. Finally, under our tuck-under acquisition program, we deployed almost $40 million during the quarter towards further growth of our FirstOnsite platform. Closing with a review of our balance sheet, we exited the second quarter with net debt at $396 million, almost identical to the levels at Q1 and prior year end. Paired with our EBITDA growth, our leverage as measured by net debt to EBITDA came in at 1.2 times, continuing to tick down from recent quarterly levels. Clearly, our strong free cash flow model continues to reinforce our balance sheet strength, even as we emerge from the pandemic and reinvest by adding capacity to meet robust market demand. Our liquidity, reflecting total undrawn availability under our revolver and cash on hand, is also sizable at approximately $575 million, providing us with ample headroom to deploy capital in support of further growth. That now concludes our prepared comments. I would ask the operator to please open up the call to questions, and thank you.

Stephen MacLeod, Analyst

I just had two questions here. Scott, you mentioned in your prepared remarks that restrictions around labor limited your growth in the quarter. I'm just curious if you're able to quantify or give an indication as to how much further you think growth would have been had you the labor to meet the demand?

Scott Patterson, CEO

You know, that's hard to know. Stephen, we've tried to come at that a few different ways. But I'm not prepared to quantify it or really able to accurately. But certainly, in our home improvement brands, we are booked out farther than we want to be. There are leads and estimates that we can't get to. I think there would have been incremental growth in home improvement, and in the other businesses it's a similar situation. We do have more open positions than we have historically at FirstService Residential. Some of our communities are temporarily short-staffed, and those would be bodies that would be reimbursable. That's also tempering the top-line in that business.

Stephen MacLeod, Analyst

Okay. But it's - okay, okay, I see. Thank you. And then maybe secondly, Scott, you gave some good puts and takes around what your Q2 expectations are in the FirstService Brands business, or sorry, back half expectations just around the home improvement restoration and Century Fire. I'm just wondering, how that stacks up on a segment, total segment basis, just when you think about all the moving parts around those three major business drivers?

Scott Patterson, CEO

I don't have that in front of me. Jeremy, do you have a sense?

Jeremy Rakusin, CFO

Yes Steve, stronger in Q3 versus Q4. But I think the aggregate piece is suffice I think you could, weight the Scott's commentary more towards Q3 versus Q4. Q4 is somewhat dependent on what happens in restoration in terms of storm activity.

Stephen Sheldon, Analyst

I just want to ask a little bit more, I guess, about the home improvement brands. I think you talked some about potentially turning away some business as you don't want a long gap between the booking and the installation for the customer, especially, I think in businesses like California Closet. So just wanted to ask, it sounds like - has that continued? And as you look across your businesses, have you seen any signs that the hiring challenges could be alleviating at all?

Scott Patterson, CEO

I don't know that we're proactively turning away business Stephen, but we have limited our marketing spend so as not to amplify our capacity issue, I would put it that way. As I mentioned, we're not getting to some leads, we're not able to provide estimates for all prospective customers, and we're booking jobs too far out. That impairs the brand experience and that's something we're working very hard to rectify through communication with customers and really proactively managing those relationships. We are making headway and improving our pace of recruiting, I would say largely because we've invested in it, we've added resources, and we've generally increased our efforts around recruiting consistently, really over this last six or nine months. So we're making headway. As I mentioned, I think we expect to see sequential improvement, particularly in home improvement in the third quarter as a result of adding capacity. But I'm not sure that the market is getting any easier or opening up at all in terms of labor. I don't know if that answers your question.

Stephen Sheldon, Analyst

No, that's helpful. Appreciate that. And then as a follow-up to the corporate expenses, I think the - I think picked up here just a little bit this quarter to just under $5 million on an adjusted basis. I just want to ask if we should expect this to be a new baseline to grow from moving forward? And I think this is the highest it has been. Are there any, I guess, unusual items in there this quarter to call out that may have driven some of that increase?

Jeremy Rakusin, CFO

Steve, it's Jeremy. Yes, I mean, compared to last year's Q2, we had significant salary cuts and other head office expense reductions. But this quarter would have reflected normalization. We accrue every quarter for bonus accruals. So there would have been a catch-up versus Q1 as we see visibility for the balance of the year. We've added a couple of additional resources at our head office as well. I'd say a mid-teens million dollars of head office or corporate costs is a good number to go forward with. We've also had FX - the stronger Canadian dollar would have also amplified maybe versus looking back a couple of years strong Canadian dollar converted to U.S. dollars would have an impact as well.

Matt Logan, Analyst

Maybe following up on the labor market and some of the challenges you're facing there. When we think about the margin, do you find that you're able to offset some or all of the rising labor costs with higher prices? Or is this simply just the fact that you can't get the labor at all?

Scott Patterson, CEO

We are experiencing some wage inflation and certainly to date, as evidenced by the margins you saw in the release, we have been able to offset that. But maybe, I'll pass it over to Jeremy, he's been digging into the wages across the company. I'll let him amplify.

Jeremy Rakusin, CFO

Yeah, sure. Thanks, Scott. As Scott said, our ability to preserve margins thus far, again I think is reflected in our results, but it is evolving. As we speak, some pockets are seeing more wage inflation than others. It does vary by service line, by role or position and by market. At FirstService Residential, we have a lot of cost-plus contracts. So our ability to pass that through directly does give us good cover. At some of our other brands, particularly in home improvement, in terms of wage inflation around our installer crews or painting crews, our ability to pass on along in terms of pricing our jobs has been good. Thus far, it's on a little bit more of a lag. So it's not a direct pass-through. But again, we keep a close eye on this, we're monitoring closely, and it's continuing to evolve, and so far, so good.

Matt Logan, Analyst

And maybe turning to your capital allocation and target leverage, how should we be thinking about tuck-under acquisitions or the potential for larger M&A with leverage now down and kind of a low one-turn range?

Scott Patterson, CEO

You know, it really did..

Jeremy Rakusin, CFO

Go ahead, Scott.

Scott Patterson, CEO

I was just going to say, it doesn't impact us in terms of accelerating activity. We have a pipeline, we have a process, we have a rhythm, and we just want to ensure that we always have the capacity to continue to drive our M&A program. Jeremy, I'll let you add to it.

Jeremy Rakusin, CFO

Yeah. Matt, I was going to make a similar point, our leverage doesn't drive how aggressive we get on M&A. It's sort of a result of it. If we grow acquisitions at mid-single digits, the chances are we may have some very modest annual deleveraging. In terms of what we do with capital deployment after our acquisition spend, we revisit with the Board. Scott and I make our recommendations. But I don't think we're at that point now; acquisition spend and size of acquisitions, again can be episodic and can change from quarter to quarter. I think we still got ample opportunities with our pipeline.

Matt Logan, Analyst

And when we take a step back and look at the M&A environment, are you seeing elevated acquisition multiples, or maybe just some color in terms of what you're seeing on the ground for residential, restoration and home improvement?

Jeremy Rakusin, CFO

It's very active in general, the market. More activity in restoration and fire protection for us, due to the active consolidation and presence of many private equity buyers, frankly. Certainly, multiples are increasing. We historically have focused on expanding our footprint with smaller acquisitions. The impact at that level is not as significant as it is, as you get to the larger companies. But certainly, we're seeing multiples increase across the board.

Matt Logan, Analyst

And maybe one last housekeeping question here for me. In terms of the storm-related activity and the large loss revenues, would the EBITDA margins be consistent with prior quarters at around 10%?

Jeremy Rakusin, CFO

Yes.

Frederic Bastien, Analyst

If we strip out the impact of weather-related events, do you think your commercial restoration activities can maintain a high single-digit organic growth in the foreseeable future through market share gains and just expansion of your services?

Scott Patterson, CEO

We do. Frederic, we do. We've certainly seen that to date. This past quarter, we grew organically at over 10%. We're investing aggressively in our sales team and we are driving new national accounts. We're also increasing the wallet share of our existing accounts. We've had success with leveraging the expertise and relationships from our tuck-under acquisitions across our footprint. A great example is the healthcare expertise set at Roland. It's been a year since we completed that deal, and we've had considerable success expanding our healthcare vertical in the last 12 months. We're seeing that in a very healthy backlog heading into the back half of the year. So you know, quarter-to-quarter, the storms will cause some fluctuation, but we do believe there will be steady and solid organic growth underlying that.

Frederic Bastien, Analyst

Great. And can you comment on sort of the rebranding efforts and how that has gone? And whether it's also driven through incremental traffic?

Scott Patterson, CEO

I mean, we're very happy with the way the rebranding has gone. It honestly feels like we've been FirstOnsite for a few years now. It's totally entrenched internally, and we believe gaining considerable traction. Externally, the one area we've seen early gains is cross border and extending national relationships that we have in the U.S. or Canada, to becoming North American relationships. Certainly, one brand and one message is helping make that happen.

Frederic Bastien, Analyst

Good to hear. Changing gears, I was a little surprised to see tuck-in acquisitions contribute as much as they did to FirstService Residential's growth. My math suggests that they would have added anywhere from $13 million to $14 million of revenue. But you don't read the press release for your tuck-in acquisitions anymore on the FirstService Residential side. So I was wondering if you could provide a bit more color on that.

Scott Patterson, CEO

Sure. Jeremy?

Jeremy Rakusin, CFO

Yeah, sure. Firstly, I'd say we're selective in what we press release. We did press release the FirstService Residential Property Management business in New York City, Midboro. There are some ancillary service providers that we acquire that are small and because they're in the ancillary category, whether that's pool or pool management, pool maintenance, fitness. If they're one-offs like that and they're small, we don't tend to press release them. So that would have probably plugged the difference between the disclosed Midboro release and our net acquisition growth.

Frederic Bastien, Analyst

And my apologies, I missed how much incremental restoration work you've got relative to the deep freeze. Would you mind just reminding me?

Jeremy Rakusin, CFO

$50 million.

Daryl Young, Analyst

Question around the restoration side. As we head into the back half of the year, as you alluded to, the hope would be to stay flat at a minimum. How should we think about some of the extreme weather events that are happening right now across North America, in terms of fire versus named storms for your business, and what - which ones would be the biggest contribution. Just if you are kind of rank through fire versus wind and hurricanes?

Scott Patterson, CEO

Wind and water damage generally generate more revenue opportunities for us, particularly with our strong footprint on the East Coast and in the Midwest. As we continue to build out our footprint on the West Coast, wildfires will become a bigger part of our business. In general, the work required around wind and water far exceeds the work required around wildfire damage, I would say.

Daryl Young, Analyst

And then just on some of the tuck-under acquisitions and I'm thinking Maxim's. You seem to be targeting much more specialized restoration tuck-unders, are there any specific verticals. I mean, you got healthcare with Roland. Are there any specific other verticals that you'd like to be in, in restoration that are more niche maybe?

Scott Patterson, CEO

I would say, we're targeting to strategically increase our footprint. Maxim's in New York City was important for us because we did not have a presence in New York City and to properly serve our national accounts, we needed a significant presence and Maxim has brought us that. It's more about footprint and the particular verticals and specialties within a company are also interesting and we take that into account. They can help drive growth, certainly as Roland has for us. We're not targeting any niche services at this point.

Daryl Young, Analyst

Okay, great. And then just one last one. I think last quarter, you mentioned on the residential side that some of the disruption of COVID has caused some Board level turnover. I'm just curious if that's - if you've seen any margin pressure or any competitive dynamics that are shaping up as you have more turnover of property management contracts?

Scott Patterson, CEO

Yeah. I mentioned last quarter that we were seeing an increase in board turnover, which generally leads or can lead to an RFP. That is proving out. We certainly saw an increase in the number of sales opportunities in Q2, and that continues into Q3. But on the flip side, we had more of our communities go out to bid than we normally see. When communities go out to bid, it attracts price competition. That would impact our margin over time. I don't think it will be material unless it continues and I think what we're going to see is it will settle down. Our sales will be up this year. But our retention will be up a little bit, our turnover of accounts will be up a little bit as well. Net-net, we still think we're going to settle into that low to mid-single digit organic growth rate as we get into 2022.

George Doumet, Analyst

Yes, good morning guys just a follow-up on the last question on the higher board turnover. I'm just wondering when you layer that in with the ongoing shortage of labor. Do you think or maybe can you still be able to hold that kind of low to mid 90% retention rate that we had in the past or do you see it Scott maybe slipping a little bit lower for a short period of time?

Scott Patterson, CEO

No, we will be able to hold it. I mean we always have - it's off maybe a point this year, but still in the 93 to 94 range. We don't see that as being an issue.

George Doumet, Analyst

And maybe for Jeremy just on that 25% organic growth number that you guys produce in the quarter. How much of that was pricing? How much of that was volume? Maybe just general comments on pricing, which areas of the business are you guys pushing harder on that?

Jeremy Rakusin, CFO

We've got many different service lines, George, so it's hard to dissect pricing at FirstService Residential; it's always modestly price competitive. We're getting good pricing again to accommodate cost increases in the home improvement business. Most of that 25% is volume predominantly.

George Doumet, Analyst

And would you like to give any comment on looking forward, how much do you guys kind of where you see pricing going, maybe through the percentages over the next couple of quarters?

Jeremy Rakusin, CFO

Don't have percentages. I think it's really about trying to cover off any cost increases. As I mentioned earlier, at FirstService Residential we have a big component that's cost-plus. So that just gets matched. The other business lines, particularly in the Brands division, will be a function of us just trying to preserve margin vis-à-vis any labor cost increases and, in some instances, very small, our material cost increases. It's hard to look at it on a quarterly basis. I've said on an annual basis, 1.5% usage of working capital as a percent of revenues is a good rule of thumb. You'll want to look at it over multi-year averages. We have the weather-related business that can really move that working capital usage. We've got cutoff times around heavy labor business and payroll timing. So you've got to look at it on an annual basis and 1.5% usage on revenue. For a $3 billion business, we're in the order of $45 million-ish, $50 million of working capital usage over a longer measurement period than just quarterly.

Scott Fromson, Analyst

Just a couple of questions first, on the home improvement businesses are you concerned about moderating growth following these COVID-related increases?

Scott Patterson, CEO

I think it will moderate, Scott. Just as you know, there is a certain level of pent-up demand that I think we're experiencing right now, and it will moderate going into 2022. But the home improvement market in general is strong; existing home sales and higher home equity will continue to provide tailwinds through 2022, we believe.

Scott Fromson, Analyst

Okay, thanks. And the just a question on the impact of inflationary pressures on residential contracts, particularly labor. Do you see an impact there or are there sufficient rate escalators that will cover off?

Jeremy Rakusin, CFO

Yes, Scott. Cost-plus contracts roughly 30%-ish of our division revenues, so that directly covers us off. On our property management contracts and anything else that's recurring contractual nature that's more than a year, they would have CPI-type price escalators built into them.

Operator, Operator

No more questions, and please continue, sir.

Scott Patterson, CEO

Thank you, Branna. Thank you everyone for joining us this morning. We look forward to continued strong results in our next report towards the end of October. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's call - this concludes the second quarter investors conference call. Thank you for your participation. Have a nice day.