RE/MAX Holdings, Inc. (RMAX) Earnings Call Transcript & Summary

Good morning, and welcome to the conference call and webcast to discuss RE/MAX Holdings' agreement to acquire RE/MAX Integra's North American regions. My name is Casey, and I will be facilitating the audio portion of today's call. At this time, I would like to turn the call over to Andy Schulz, Senior Vice President of Investor Relations. Mr. Schulz, please go ahead, sir.

Thank you, Casey, and good morning, everyone. Please visit the Investor Relations page of remax.com for all related materials to today's announcement and to access the live webcast and a replay of the call today. Turning to Slide 2. Our prepared remarks and answers to your questions on today's call may contain forward-looking statements. Forward-looking statements include statements about the acquisition of the RE/MAX INTEGRA North American regions, including statements about the closing of the transaction and the benefits of the transaction as well as statements related to agent count, franchise sales, financial measures and outlook, brand expansion, competition, technology, housing and mortgage market conditions, capital allocation, dividends, strategic and operational plans and business models. Forward-looking statements represent management's current estimates. RE/MAX Holdings assumes no obligation to update any forward-looking statements in the future. Forward-looking statements address matters that are subject to risks and uncertainties that may cause actual results to differ materially from those projected in forward-looking statements. These are discussed in our related press release and other SEC filings. Also, we will refer to certain non-GAAP measures on today's call. Please see the definitions and reconciliations of non-GAAP measures contained in our most recent quarterly financial results press release, which is available on our website. Joining me on our call today are Adam Contos, our Chief Executive Officer; Karri Callahan, our Chief Financial Officer; and Nick Bailey, President of RE/MAX LLC; Ward Morrison, President of Motto Franchising, will join us for the Q&A. With that, I'd like to turn the call over to RE/MAX Holdings CEO, Adam Contos. Adam?

Thank you, Andy, and thanks to everyone for joining our call today. We are thrilled to discuss with you our agreement to acquire RE/MAX INTEGRA's North American regions for $235 million in cash. The purchase, which we expect to be accretive in year 1 is, by far, the most significant independent region acquisition in the history of our company. RE/MAX INTEGRA is our largest independent regional operation and includes 5 Canadian provinces and 9 U.S. states, covering many local markets where RE/MAX thrives in terms of brand presence and market share. Adding these strategic geographically desirable regions will strengthen the inherent financial framework around our regional operations. It also will advance our ability to scale, deliver value to affiliates, bring additional growth opportunities as well as simplify our operational structure. As many of you know, acquiring independent regional franchises has long been a capital allocation priority for us and a key pillar of our growth strategy. We typically receive between 15% and 30% of an independent regions fee revenue. In acquiring an independent region, we can recapture the additional 70% to 85% of revenue previously earned at the regional level. In addition, because we're acquiring a part of our existing network, we believe the integration risk that normally accompanies an M&A transaction is relatively low and that we are able to leverage operational synergies in providing support, services and products. This is why independent region acquisitions are so attractive and accretive to our business. This acquisition is subject to customary closing conditions and is expected to close in the third quarter. Here are the highlights. As I mentioned earlier, INTEGRA'S North American operations span 9 U.S. states and 5 Canadian provinces. That includes the 3 midwestern states of Minnesota, Wisconsin and Indiana, as well as all of the New England states: Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont. We're also acquiring the Ontario Atlantic Canada region, which includes Ontario as well as New Brunswick, Newfoundland and Labrador, Nova Scotia and Prince Edward Island. After the transaction closes, only 5 independent regions will remain: 4 in the U.S. and 1 in Canada. Once completed, the acquisition will add nearly 19,000 agents, approximately 12,000 in Canada and 7,000 in the U.S. as well as more than 1,100 independently owned and operated RE/MAX offices to our company-owned region umbrella. For context, INTEGRA'S North American operations comprised about 65% of the combined U.S. and Canada independent region agent count as of March 31. Before I turn the call over to Nick, I want to thank the RE/MAX INTEGRA co-founders, Frank Polzler and Walter Schneider, and their amazing families for their dedication and passion in growing the RE/MAX brand for more than 40 years. They will still own and lead RE/MAX INTEGRA's RE/MAX Europe region, where they'll continue to have a positive impact on region owners, franchisees, sales associates and consumers. Now I'll turn the call over to Nick.

Thank you, Adam. Turning to Slide 4. From an operational perspective, when I think of all the positives that come with this acquisition, the list is very long and compelling. We'll gain greater speed and consistency as well as enhanced ability to scale and more opportunities for overall growth. All these factors should benefit our customers, brokers, agents and consumers alike. An inherent challenge with independent regions is having more -- one more step to every process and decision or one more system or vendor to deal with. Bringing these regions in-house will simplify the critical path with every major decision and initiative, which significantly will speed things up. And perhaps now more than ever, speed to market is essential. Adding 19,000 agents to our company-owned regions gives us the opportunity to scale faster than we've been able to in the past. It means more agents on the same systems, using the same products, combining resources and delivering a more consistent consumer experience. Plus, the timing really could not be better. Historically, RE/MAX has been a story about scale. And the latest chapter in this book is being written now as we're reaching critical scale with our newly revamped technology stack. We are just beginning to gain transaction with our -- traction with our tech suite rather. So this is an optimal time to bring our biggest client back under the tent. It means more RE/MAX agents will have unfettered access to our tools, training and tech developed and curated for our unique culture of highly productive agency teams. In terms of growth and opportunity, the acquisition further supports our main drivers of organic growth, increased agent count, additional franchise sales and tech opportunities, among others. Plus, given the similarity of our operations, we'll be able to take advantage of and realize multiple operational synergies. In the U.S., for example, the acquired regions will be absorbed into our existing company-owned region organization, which means that most of the necessary support structures and services are already in place. After all, our team supports over 48,000 U.S. agents now. So the addition of 7,000 more should bring more opportunities than challenges. In fact, having 55,000 U.S. affiliates in the company-owned regions aligned and using the same systems should mean more cohesion consistency and product adoption across the board. Ultimately, the same should be true in Canada, where affiliates will see many benefits of having even tighter alignment across the country. The Western Canada and Ontario regions already worked closely on many things like events and market reports, and this move will add even more consistency to the mix. RE/MAX has been a clear industry leader in Canada for a decade, and this acquisition positions us for even better things in the future. I'm anticipating many opportunities to merge the best of Western Canada and the best of Ontario, Atlantic Canada to create something even more powerful across the entire country. Christopher Alexander, who's been leading INTEGRA's Canadian region over the past few years will join our team and partner with Elton Ash, who runs our company-owned region in Western Canada, to guide a smooth transition and ongoing development of integrated services across Canada. Our newly combined Canadian operations will also continue to work with the outstanding independent region team in Québec. Lastly, our tech expansion into Canada is set to launch later this year. We'll bring our booj platform up north, and that's just going to be the beginning. We see a huge opportunity to improve our digital presence at every level with the goals of driving business to the agents, creating the best consumer experience possible. A better consumer search experience drives greater traffic to our digital assets, which in turn builds business for our affiliates. That's our motto, everybody wins. So for the remainder of 2021, our focus will be on completing a smooth and seamless transition and enabling the ongoing success of the franchisees and agents in the acquired regions. Already, our teams are engaged in discussions with our brokers and agents and strategizing with them on how we'll continue to support their growth. We're conducting virtual ask us anything sessions starting today, so the brokers in these regions can speak directly with our leadership and feel comfortable with the transition. Our franchisees expect and deserve the absolute highest level of support, and we intend to deliver on that. The transition will commence as soon as the deal closes. We expect the membership in all of these regions to recognize the incredible value of being in a company-owned region. With that, Karri?

Thanks, Nick. Looking at Slide 5. We are extremely excited with our agreement to acquire RE/MAX INTEGRA'S North American business. We have remained steady and resolute in executing on our capital allocation priorities over the past few years. Our balance sheet discipline and patience have paid off as we have kept our powder dry to be able to act on an opportunity like this should one present itself. Committed financing has been secured on terms consistent with our existing credit facility. Financing this acquisition exclusively with debt made the most financial sense and should give us a more efficient capital structure going forward. After adding the expected EBITDA contributions from the acquired regions, we expect our leverage to increase to a still comfortable level of approximately 3x on a net basis and approximately 4x on a gross basis. The cash-generative nature of our legacy business, combined with similar financial characteristics of the acquired assets, plus more than $100 million of cash on hand provides us with the flexibility to continue to invest and act opportunistically when we come across other attractive opportunities, which fit within our strategic plans. Turning to Slide 6. As Adam mentioned, the transaction is subject to customary closing conditions, and we expect it to close next quarter. Consequently, we are not updating our 2021 guidance at this time. Once the transaction closes, in the first year of our ownership, we expect INTEGRA's North American operations to generate revenue in a range of $52 million to $55 million, including revenue from its marketing funds in the range of $19.5 million to $21.5 million; adjusted EBITDA in a range of $19 million to $21 million; and adjusted EPS in a range of $0.22 to $0.26 per diluted share. Two items to note with respect to these expectations. First, the aforementioned estimated revenue and adjusted EBITDA contributions are each lower by approximately $1 million because accounting rules preclude us as the acquirer from recording the seller's deferred revenue balance from franchise sales and renewals. This will initially result in us recognizing less franchise sales revenue than the seller did previously. But importantly, it has no impact on the overall cash flows of the business. And second, these projections assume no further currency movements, acquisitions or divestitures and would be incremental to our legacy business. With that, I'll turn it back to Adam.

Thank you, Karri. Turning to Slide 7. In summary, we cannot be more pleased to have entered into this agreement to acquire the RE/MAX INTEGRA North American regions. This significant milestone in our history adds increased scale, speed, growth and opportunity to RE/MAX at a time when the real estate market continues to show incredible resilience and strength. It is a win for our affiliates, our consumers and our investors. We can't wait to close the transaction and begin realizing the many added benefits we believe it will bring to RE/MAX and our stakeholders. With that, operator, we would like to open it up for questions.

[Operator Instructions] And your first question here comes from Anthony Paolone from JPMorgan.

Congratulations. My first question is as it relates to operations and bringing the regions in-house, what do you specifically intend to do differently perhaps in the first few quarters or the first year compared to what the owners currently have been doing?

Thanks for the question. This is Nick. First and foremost, I mentioned we're going to be integrating the U.S. operations into our existing central and northeast regions. And so we will take the opportunity between now and close to put the plan together on all of the leadership, communicating with all of the owners. But that's step #1 is to integrate them. From there, as far as something that we will do different, actually the good news is we operate the regions very similar as to the previous independent owners. So we're just going to gain the synergies and the opportunity to align systems, create more consistency for agents and brokers that will transition or trickle down to consumers. So it's really not about doing something different. It's really just -- it's really more about integrating for scale and smooth operations overall.

Okay. And I don't know if you can point to just experience on past independent region acquisitions or just your thought process in underwriting this acquisition. But how do you think about just the potential for breakage of franchisees or conversely, the opportunity to recruit or grow? Like is there any low-hanging fruit that perhaps wasn't being captured or risk to the downside?

Yes. So because of the nature of how our franchise agreements are structured, we're not worried at all about breakage because those contracts are part of the acquisition of the assets of the deal and the terms of those agreements remain in place as they would with each one of the franchisees. So no risk there. What any type of move like this because of the synergies, the systems, the excitement, the communication, those are all great opportunities to put the growth pedal pushed a little stronger. And so there's only upside when it comes to being able to pull these in under one umbrella and drive growth from one voice instead of 2.

Okay. And then just a couple of financial ones, maybe for Karri, just to make sure I understand. The revenue and EBITDA that you're showing from this, that's net of the $1 million that comes out. Is that right?

That's correct. So the $1 million is something that basically gets lost at the time of acquisition related to that deferred revenue. So it's revenue that we will not able to record on a go-forward basis. If there wasn't that nuance, you're correct, the revenue and the adjusted EBITDA numbers would be $1 million higher.

Okay. And then this -- these numbers, particularly the revenue number, does that include or exclude the annual dues that, I guess, you're already getting?

So that -- this is truly what would be incremental. So the annual dues from those agents is included already in our legacy business. And so this is just the incremental revenue that comes from the changeover from the approximately 19,000 agents converting from independent regions to company-owned regions.

Okay. Got it. And then so does that account for the difference? I mean, if I look at the number you mentioned, you expect $2,275 per agent in terms of this deal. That includes the annual dues, I assume?

Yes, that does.

Okay. Got it. And then, I guess, just last question on that. It seems like you're bringing in about $13 million of incremental costs on this deal. Just wondering what the big buckets of that are like what do you have to bring in here?

Sure. So I mean obviously, as Nick mentioned in the scripted remarks, we're very focused on making sure that we provide a consistent experience for our franchisees and agents in terms of support staff. We run a very efficient and lean staff, and we want to make sure from a personnel perspective, we've got the right support, not only from the front-end franchise perspective, but also as we look to optimize the technology across both the U.S. and Canada with the rollout up in Canada next year from a personnel perspective that we're continuing to allocate the appropriate resources.

Okay. So it's mostly -- it's people, right? It will be -- this will be personnel in terms of the bucket, really?

Yes.

Your next question comes from the line of Tom McJoynt from KBW.

So on one of the slides you mentioned that the Canada agents and company-owned regions are a bit lower due to the legacy agent economics and the impact of foreign exchange rates. Can you quantify how much of that is driven by exchange rates and how much is from legacy? And is that kind of legacy aspect kind of running off over time, perhaps over kind of a longer time period?

Sure. Tommy, the vast majority of that is really driven by exchange rates. And so I would say that's the vast majority of it. In terms of just kind of the legacy structure, those are things that we're going to evaluate over time. As Nick mentioned, there's multiple different opportunities for growth here. And so we'll just continue to evaluate what we think the right pricing mix looks like and be able to leverage that going forward based on what we think the right opportunities are for the business.

Okay. Great. And so it looks like the EBITDA margins on this incremental business are fairly consistent with your overall business. So is it fair to say that kind of the margins are pretty similar between company-owned franchises and the independent regions in terms of those revenues?

Yes. So I mean, if you look at just the stand-alone margin, obviously, it's significantly higher than what we're looking at. So kind of on a pro forma basis, we're looking at about 200 basis points of margin improvement. So I think, again, we think that there's a lot of opportunities here and instantly accretive. And so really excited about the opportunity and what it brings to the future financial and operational performance of the company.

Your next question comes from the line of Ryan McKeveny from Zelman & Associates.

Congrats on the deal. One follow-up on that last response. So on the EBITDA margin, kind of the 200 basis points or so above kind of the corporate business. Is that a function of like INTEGRA preexisting running at a higher margin? Or is that factoring in incremental synergies that come over once you guys kind of own that business?

Yes. So what I was saying there, right, if you basically just look at our legacy business and the guidance that we provided back in May and then add this on to it, right, you've got an incremental upside, right? And so I think as we just look at the synergies and the opportunities that this brings, it's kind of a combination of the 2.

Got it. Okay. Makes sense. And on the revenue buildup in the marketing fund revenue, I guess it looks as though what's coming over kind of the marketing fund as a percent of total revenue looks to be higher with INTEGRA than 2020 corporate results. Anything to that or any comments you could share on kind of why that's the case?

No. So I mean, as we look at that, right, all of the different regions have their own cost structure with respect to marketing spend. And some of those regions are just a little bit -- we're just a little bit higher. And so obviously, we're looking at how we optimize all of the marketing spend. One of the biggest competitive advantages that we have is the brand and then the structure to be able to pool those dollars from a marketing fund perspective. And so we think it's actually an advantage as we look at deploying marketing and technology across all of the acquired regions.

Okay. And 2 more very quick ones. Is there any stock comp assumption kind of being added back to the adjusted EBITDA guidance? And then second question, just to confirm on the deferred revenue dynamic, is that -- I know it's just kind of accounting noise, but is that just a function of when a franchise is sold, it's kind of amortized over a longer period of time, and the cash component has already happened. So even though the revenue goes away, that's kind of why the cash impact doesn't matter. And then as you guys from kind of starting point, ground 0, build up your own franchise sales within this, that would ramp back up over time. Is that the right way to think about that?