K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the K-Bro Linen Inc. First Quarter 2020 Results Conference Call. [Operator Instructions]I would now like to hand the conference over to your speaker today, Kristie Plaquin. Thank you. Please go ahead.

[Kristie L. Plaquin, Chief Financial Officer]

Thank you, operator, and good morning, everyone. Thank you for joining us today, and welcome to our 2020 first quarter results conference call. On the line with me today is Linda McCurdy, President and Chief Executive Officer. I would like to remind everyone that statements made during our prepared remarks or in the Q&A portion of the conference call with reference to management's expectations or our predictions of the future are forward-looking statements. All statements made today, which are not statements of historical fact are considered to be forward-looking statements. Certain material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection are reflected in the forward-looking information. The business prospects of K-Bro Linen Inc. are subject to a number of risks and uncertainties that may cause actual results to differ materially from a conclusion, forecast or projection in the forward-looking information. Actual results could differ materially from those anticipated. Risk factors that could affect the results are detailed in the corporation's public filings. Please note that K-Bro is under no obligation to update any forward-looking information discussed today. Investors are also cautioned not to place undue reliance on these statements. For more information about these risks, uncertainties and assumptions, please refer to our annual information form and our MD&A, which are available on SEDAR or our corporate website. I'll now turn the call over to our CEO, Linda McCurdy, who will provide her insights and remarks on the quarter. Linda?

[Linda Jane McCurdy, President, CEO & Director]

Thank you, Kristie. Good morning, everyone, and thank you for joining us today to review our first quarter results for 2020. While we all know how much has changed since our year-end results in light of COVID-19, first, I hope you're all healthy and safe during these very challenging times. I want to start by acknowledging the hundreds of dedicated K-Bro employees that are coming to work every day to ensure health care institutions receive hygienically clean linen. As we all know, they play a critical role in the protection of our frontline health care workers. We'll begin the call today with a review of our first quarter results for 2020. We'll comment on debt and liquidity, and then I'll provide a full update on the impact of COVID to K-Bro and the progress of our current plans to mitigate the effects. Well, obviously, COVID-19 will impact us. As a backdrop, the last half of 2019 and the first 2 months of 2020 showed that our underlying operations and financial performance have returned to historical levels, especially with regards to margin. That's important for us to know as we plan for the time when we get through the impact of COVID-19, while also remaining prepared for when the impact of the virus eventually begins to recede. From a revenue perspective, on a year-to-date basis, our consolidated hospitality segment represented 38.8% of overall revenue compared to 40.9% in 2019. Hospitality revenue decreased by 14.7% in Canada and increased by 3.6% in the U.K., with a consolidated decrease to hospitality revenue of 6.1%. Our health care segment has also experienced growth of 2.8% over the same period last year, which has been primarily from organic growth and contractual rate increases. As evidence of a solid start to the year, revenue remained strong until the last 2 weeks of the quarter, with year-over-year revenue increasing 5.2% for the first 2 months of 2020. However, starting March 11, 2020, COVID-19 began to have an immediate effect with many of the corporation's hospitality customers experiencing significantly reduced occupancies or closures as a result of the implementation of lockdown and confinement measures. As a result, for the month of March, consolidated revenue decreased by 11.5% compared to the same period in 2019. In response to this unprecedented situation, we very quickly acted to scale down our operations by reducing headcount, consolidating volumes into a reduced number of plants as well as streamlined distribution routes. Currently, we've reduced our days of operations from 7 days to 1 to 3 days in all of our Canadian hospitality plants and have temporary closed -- temporarily closed 2 of our 4 linen processing plants in the U.K. As a reminder to everyone, we have 4 Canadian plants that are primarily hospitality, 3 of which are our smallest Canadian plants. We've reviewed our CapEx and made certain adjustments that won't impact our plans going forward as businesses open up, with the only significant CapEx deferral being an enterprise-wide operating system installation that we're not able to proceed with given COVID-related work restrictions. And finally, we're pursuing all government relief programs put forward by government. In terms of EBITDA, while it decreased in the first quarter to $3.7 million from $9.1 million in 2019, which is a decrease of 58.9%, this was substantially as a result of an impairment to assets recorded for K-Bro's smaller Canadian hospitality plants, which were significantly impacted due to the COVID-19 pandemic. Again, the changes in EBITDA relate primarily to the effects of COVID and the impairment of the assets of $5.5 million due to certain cash-generating units within the Canadian division. On a consolidated basis, EBITDA without the adoption of IFRS 16 and the impairment of assets in the first quarter was $7.1 million compared to $6.8 million in the comparative period of 2019. Consolidated adjusted EBITDA margin was 12.4% in the first quarter of 2020 compared to 11.8% in the comparative period 2019. To illustrate just how much of an impact COVID had beginning in March on a consolidated basis, adjusted EBITDA without the adoption of IFRS 16 and the impairment of assets for the first 2 months of 2020 increased by $1.8 million compared to the same period of 2019. Consolidated adjusted EBITDA margin was 12.7% for the first 2 months of 2020 compared to 8.5% in the comparative period of 2019. Net loss for the first quarter was $3.4 million or $0.32 per share basic. Cash generated by operating activities for the quarter was $11.6 million, and distributable cash flow was $6.1 million. The net loss included a charge related to an impairment of assets at 3 of our smaller Canadian hospitality plants in the amount of $4.3 million after taxes, which we'll provide more details on later. Revenue decreased in the first quarter of 2020 to $57.3 million or by 0.9% compared to 2019. This decrease was primarily related to the reduction in hospitality revenues due to COVID, partially offset by the acquisition of an Aberdeen laundry, organic growth at existing customers and new customers secured in existing markets. I'll now turn the call over to Kristie to discuss our detailed financial results for the quarter, after which I'll return to talk about the remainder of the year. Kristie?

[Kristie L. Plaquin, Chief Financial Officer]

Thank you, Linda. The information we are discussing today is also highlighted in our first quarter and 2020 earnings press release issued yesterday. And detailed supplemental financial information can be found on our Investor Relations website under the heading Financial Documents. In Q1 2020, approximately 61.2% of K-Bro's consolidated revenue was generated from healthcare institutions, which is higher compared to 59.1% in 2019, primarily related to the significant falloff in hospitality volume in March. On an adjusted basis, without the adoption of IFRS 16 and the impairment of goodwill, EBITDA increased by 4.5% to $7.1 million, with an adjusted EBITDA margin of 12.4%, which was 15.7% in Canada and 1.9% in the U.K. Wages and benefits in the first quarter of 2020 decreased by $0.7 million to $22.7 million compared to $23.4 million in the same comparative period of 2019, and as a percentage of revenue decreased by 0.9% to 39.6%. The decrease as a percentage of revenue is primarily related to improvements in labor efficiencies and offset by escalating minimum wage rates. Linen in the first quarter of 2020 increased by $0.3 million to $6.7 million compared to $6.4 million in the same comparative period of 2019, and as a percentage of revenue increased by 0.5% to 11.7%. The increase as a percentage of revenue is primarily related to the higher proportion of health care revenue processed in the quarter. Utilities in the first quarter of 2020 decreased by $0.7 million to $3.6 million compared to $4.3 million in the same comparative period of 2019, and as a percentage of revenue, decreased by 1.3% to 6.2%. The decrease as a percentage of revenue is primarily related to lower utility costs in British Columbia as a result of a temporary natural gas supply shortage during the first quarter of 2019 and lower commodity costs. Delivery in the first quarter of 2020 remained constant at $7 million compared to the same comparative period of 2019 and as a percentage of revenue increased by 0.2% to 12.3%. The increase as a percentage of revenue is primarily related to fixed costs that remain constant regardless of the reduction in volumes from COVID-19. Price increases from renewals without first freight contracts, offset by lower cost of diesel and external freight charges tied to the diesel price. Occupancy costs in the first quarter increased by $0.1 million to $1.2 million compared to $1.1 million in the same comparative period of 2019, and as a percentage of revenue, increased by 0.1% to 2%. The increase as a percentage of revenue is primarily related to fixed costs that remain constant regardless of the reduction in volume from COVID-19. Materials and supplies in the first quarter of 2020 increased by $0.3 million to $2.1 million compared to $1.8 million in the same comparative period of 2019, and as a percentage of revenue increased by 0.7% to 3.7%. The increase as a percentage of revenue is primarily related to the fixed costs that remain constant regardless of the reduction in volume from COVID-19 and onetime cost recoveries in the prior year. Repairs and maintenance in the first quarter of 2020 increased by $0.1 million to $2.2 million compared to $2.1 million in the same comparative period of 2019, and as a percentage of revenue, increased by 0.2% to 3.8%. The increase as a percentage of revenue is primarily related, again, to the fixed costs that remain constant with COVID and timing of maintenance activities. Corporate costs in the first quarter of 2020 remained constant at $2.6 million compared to the same comparative period of 2019, and as a percentage of revenue, increased by 0.1% to 4.6%. The increase as a percentage of revenue is primarily, again, related to the COVID-19 and the nature of fixed costs and the timing of initiatives to support the corporation's growth and business strategies across the plant. I'll now address the goodwill impairment loss that we recorded in the quarter, which was $4.3 million net of tax at 3 of our smaller Canadian cash-generating units. Given the significant effect that COVID has had to the hospitality sector, we consider this to be a triggering event and as such, assess the impairment indicators for all 5 of our primarily or entirely hospitality-based cash-generating units using a probability-weighted approach. For 3 of the smaller Canadian cash-generating units, which had performed on a more average basis historically, there were indicators of impairment. And in accordance with this, we wrote the goodwill down or off during the quarter. For the remaining hospitality cash-generating units, which were Vancouver 2 and the U.K. division, which had performed at above that average rates historically, they showed more headroom. And as a result, no impairment loss was recorded. We will continue to monitor this situation as it pertains to COVID-19 and further consider if there are new or additional indicators that exist during the year. Depreciation of property, plant and equipment and amortization of intangible assets represents the expense related to the appropriate matching of certain K-Bro long-term assets to the estimated useful life in period of economic benefit of those assets, and it remained consistent quarter-over-quarter. Now looking at our capital resources. Distributable cash flow for the first quarter of 2020 was $6.1 million and our payout ratio was 52.4%. In addition, the company paid out $0.30 per share in dividends during the quarter for total consideration of $3.2 million. The corporation had net working capital of $26.6 million at March 31, 2020, compared to its working capital position of $31 million at December 31, 2019. The decrease in working capital was primarily attributable to a decrease in cash and cash equivalents, timing difference related to the cash settlement of new plant equipment, income tax payments, deposits related to the acquisition of equipment across the plants and cash receipts from customers. At March 31, 2020, total assets increased to $336.1 million compared to $352 million at December 31, 2019, and total liabilities decreased to $144.6 million from $156 million. Shareholders' equity decreased slightly at March 31, 2020, from December 31, 2019, to $191.5 million from $196.1 million. As far as our debt is concerned, we have sufficient room in our credit facility, with an operating line of $100 million and an undrawn balance of approximately $45 million, reinforcing our strong liquidity. We don't expect any covenant issues for the balance of 2020. We have had excellent conversations with our lender and while there are no imminent covenant issues, we are in discussion about further flexibility with regard to our covenants, and they are amenable. Debt to total capitalization for the quarter ended March 31, 2020, was 22.3% and the corporation's unused revolving credit facility of $44.2 million has not incurred any events of default under the terms of the credit agreement. Total debt in the quarter decreased from $62.5 million to $54.7 million. We continue to monitor and aggressively pursue accounts receivable collections. At this point, we do not anticipate that there will be material receivables which are uncollectible. I'll now turn things back over to Linda for additional commentary. Linda?

[Linda Jane McCurdy, President, CEO & Director]

Thank you, Kristie. I'll now make a few comments regarding April. We continue to see significantly lower hospitality activity, but we also saw a drop in health care revenues as hospitals canceled elective surgeries and reduced occupancy rates to prepare for COVID surges. Consolidated revenue for April 2020 decreased by approximately 45%, with a decrease in consolidated health care revenues of approximately 10% and a decrease in consolidated hospitality -- hospitality revenue, with approximately 90% compared to the same period last year, with both the Canadian and U.K. divisions seeing hospitality revenue drop by the same percentage. As we enter May, we have seen some rebound from a health care perspective, but it is really too early to predict with any level of accuracy where we might see it -- when we might see it return to normal levels. What we do take comfort in is that some provinces have begun to announce their plans to reopen the economy, which also includes elective surgeries. In terms of hospitality activity coming back to pre-COVID levels, that too, is hard to predict with any level of certainty. However, we don't anticipate that this segment will recover anywhere near as quickly as health care revenues. For context, we are not seeing any change in April and May with regards to hospitality revenues from what we saw in the second half of March. So volumes are still close to 0. So really, what I'm saying here is that as far as an outlook for 2020, it's really hard for us to predict what it will look like with any degree of certainty, as even knowing Q2 will be materially impacted, and we hope to see health care returning close to usual levels later in Q2 or in Q3. We remain well positioned from a balance sheet and liquidity perspective, as Kristie discussed, in addition to strong concentration of our Canadian revenues from the health care sector at approximately 70%. We are continuing to monitor our situation carefully, and we'll consider any and all actions, including any opportunities that will allow us to come out of this downturn in a stronger market position. We continue to evaluate tuck-in acquisitions in both the U.K. and Canada as we execute on our strategy to grow our market share, and this will continue as we move forward in 2020 and current conditions may lead to opportunistic situations for us. We've announced a number of times about our dividend policy. We've discussed whether to make changes to our $0.10 per share dividend, and we've determined that the best policy is to maintain our dividend -- our current dividend. We don't have a single metric that we -- that determines our dividend policy. But given our expectations for Q2 and for our outlook for the remainder of the year, we do not believe it's necessary or prudent to change the dividend. Obviously, the situation is fluid with both health care and hospitality volumes, much more uncertain than normal. And as such, we will regularly reexamine our dividend policy and. If our performance or our outlook changes, then we'll consider whether any change is warranted. Finally, we're committed to the safety of our employees, customers and communities, and we've put in place strict policies to do our part to minimize the potential spread of this virus. To date, we are very fortunate that all of our employees remain healthy. This is of utmost importance, and we will continue to ensure that all measures are in place to protect their safety. I'll now turn it over for Q&A with regards to the quarter.

[Operator]

[Operator Instructions] And your first question here comes from the line of Michael Glen with Raymond James.

[Michael W. Glen, Equity Research Analyst]

Just -- can you just maybe dig into the wages and benefits cost profile? And can you provide some insights into how we might think about the fixed variable cost on that line item as we work in Q2 and through the balance of the year?

[Linda Jane McCurdy, President, CEO & Director]

On a direct labor -- from a direct labor perspective, I don't expect wages and benefits to go up material as a percentage of revenue. We've given some guidance on revenue. From a fixed cost perspective, there obviously are fixed costs to the business in terms of occupancy costs as well as, in particular, distribution costs where we have full-service leases. I guess, what I would say is, obviously, it will have an impact on our overall outlook in terms of EBITDA margin because of those fixed costs. I would expect it would be somewhere in the range -- we would be in the range of 10% to 15% in terms of overall EBITDA margins for the company, for the year, depending upon how revenues plays out.

[Michael W. Glen, Equity Research Analyst]

Okay. No, that's great information. And then just on the health care volumes, do you think there's a scenario where there could be some catch-up that takes place? Is that a possibility as things reopen on some of the business that would have been shut down?

[Linda Jane McCurdy, President, CEO & Director]

I think there's 2 things at play here. I think there will be catch up. Revenues, as we mentioned, on the health care side are down 10%. But that is has been offset by increases in certain products. So as electives catch up, the increased volumes of certain items and the elective surgeries, we are hopeful that historical volumes will resume, would be our best outlook. Even though we have -- we believe they will leave capacity for COVID surges.

[Operator]

Your next question comes from the line of Justin Keywood with Stifel GMP.

[Justin Keywood, Director of Equity Research]

Just on the health care volume, I'm just trying to understand that dynamic a bit better because how I understand it, the capacity utilization was reported at only 60%, at least in Ontario but you're showing a 10% decline in April. And then you mentioned there's some increased hygienic practices. But are there also more beds that have been added, perhaps that can point to that lower utilization rate? And do you anticipate that added capacity to remain beyond COVID-19, illustrating some higher growth in the hospital segment, if I'm reading this correctly.

[Linda Jane McCurdy, President, CEO & Director]

Yes. I think that's a good observation because capacities in hospitals were well below, as you said, at the 60% mark. Yet, our revenues are down 10%. So that's -- there are a number of factors. There are the temporary facilities that have been put in place, which we serviced in many of our markets. We have done some backup service for long-term care facilities, which may translate into more permanent volumes. And there have been additional usage and I would say, change in practice that may very well continue into the future. And the third point is we definitely have seen a conversion of certain products from disposable to reusable, which I would expect to continue into the future as well. So I do think when normal returns, there is upside potential on the health care side.

[Justin Keywood, Director of Equity Research]

That makes sense. Would you be able to clarify being a backup for the long-term care facilities?

[Linda Jane McCurdy, President, CEO & Director]

Sure. There are a number of long-term care facilities who, as we all know, have experienced significant outbreaks. Many of them do their laundry -- process their laundry in-house. There have been circumstances where their concerns for their own staff have resulted -- concerns being sicknesses, absent -- or people not having enough employees to process the linen, they have asked us to process the work for them, which may lead to permanent closure of their laundry.

[Justin Keywood, Director of Equity Research]

And do you anticipate that to be a material impact on the business, maybe coming out of this situation?

[Linda Jane McCurdy, President, CEO & Director]

I do think given the number of long-term care facilities who process their volume in-house, that it will be something they look at very seriously. And that's not an insignificant volume in the context of overall health care business. So it may not happen overnight, but I do think that is a real opportunity.

[Justin Keywood, Director of Equity Research]

And the long-term care business for K-Bro, can you remind us, was that a large portion of revenue prior? Or are there many customers?

[Linda Jane McCurdy, President, CEO & Director]

Depending on the market, it is probably 10% of our revenue, but there still remains -- there remains a significant amount of volume in-house. It varies market by market and from the private sector, long-term care operators, much of that is done on-premise.

[Operator]

Your next question comes from the line of Ammar Shah with Eight Capital.

[Ammar Shah, Research Analyst]

Linda, in your prepared remarks, you talked about the potential for tuck-in acquisition opportunities. I'm just wondering if you can maybe touch on that a bit more in terms of where valuations or multiples or the relationship between buyer and seller maybe have gone, given everything that's going on with COVID-19. Has that changed materially to the point where, like you said, there's significant opportunistic opportunities or kind of more of a wait-and-see approach?

[Linda Jane McCurdy, President, CEO & Director]

I think it is still early days. I will say that it will change the dynamic. I can't comment on valuation. I think that's too premature. But I do believe this is going to have a very material impact on smaller owner-operators who are predominantly hospitality. It is a very difficult, difficult time. And despite the fact that there are government assistance programs that is just not going to solve the problem of 90% of your -- 95% of your revenue going away in the short-term; and in the medium term, a recovery that's going to take some time. So I am highly confident that there's going to be opportunities, I think it is a bit premature.

[Ammar Shah, Research Analyst]

Got it. Makes sense. And I guess, switching gears to the U.K. I'm just wondering, you had mentioned a kind of alternative potential source of revenue in Canada with the long-term care facilities. Just curious, is there -- like, I know the health care segment still kind of -- in terms of a portion of revenue, still small in the U.K., but I'm just curious, is there some sort of a, call it, low-hanging fruit or something that could be tapped into from the health care standpoint that could result in a little bit of reprieve for the, predominantly, hospitality business?

[Linda Jane McCurdy, President, CEO & Director]

I would say what this has done has given us an opening for dialogue and discussions. In Scotland, most of the health care work is done in health. We have had early discussions. Again, I think it opens the door for discussions in the future and as things return to normal, everyone today is focused on getting through the crisis. But again, it enables us to have a healthy discussion about opportunities.

[Ammar Shah, Research Analyst]

Perfect. And then just one final one for me. I think last quarter, you had -- you guys commented that from a supply of linen standpoint, you had -- you have that reserve. And I'm just curious, are things on that front still sort of intact? Or any change in commentary there?

[Linda Jane McCurdy, President, CEO & Director]

We're very pleased on how we have fared in this as it relates to supply chain, both in terms of our existing relationship with -- relationships with our suppliers as well as contingency plans and inventory that we restore just as a normal course of business. There's no question that the supply chain is taxed and stretched and strained on various items. But I will say, on balance, we have fared extremely well, being able to service our customers in certain cases, well, I can say, unequivocally across the country on certain items, we have doubled our ability to supply certain products, which I see as quite unprecedented, and we're very happy to be able to service our customers in that way.

[Operator]

Your next question comes from the line of Endri Leno with National Bank.

[Endri Leno, Associate]

Thanks for taking my questions. Most of them have been asked and answered, but I just wanted to focus a little bit or start at least on the U.K. operations. So when you're running the test for an impairment charge and you take one on the Canadian side, I was just wondering if you can give a little bit more color on the U.K., at least conceptually and beyond just a pure math, of why wouldn't there be no impairment in the U.K., given it's almost 90% hospitality?

[Linda Jane McCurdy, President, CEO & Director]

Sorry, I didn't quite catch your question, Endri. It's -- the line is a little bit poor. I got the U.K., why wouldn't -- sorry?

[Endri Leno, Associate]

Yes. No. Why wouldn't there be an impairment in the U.K. hospitality side, I mean, given that it is almost hospitality, at least like a conceptual -- kind of like a bit of a color or discussion beyond the pure math of it.

[Linda Jane McCurdy, President, CEO & Director]

Got it. Okay. Kristie, go ahead.

[Kristie L. Plaquin, Chief Financial Officer]

Yes. I think, Endri, especially Fishers is a larger plant. There was just more headroom in terms of the volume. We did do an impairment test, and we assumed a reasonable level of recovery, but it certainly wouldn't, I guess, anticipate that what we saw in April repeats itself over the next 12 months. We would assume there would be some level of comeback in volumes, and it's something that we'll have to continually monitor and evaluate as we move throughout the year, just in terms of it's -- it is difficult right now to predict with any firm degree of accuracy, where the -- how the volumes will come back.

[Endri Leno, Associate]

Okay. Okay. And then since we are on the U.K., I just wanted to -- like the cost year-over-year. I mean for the 2 comparable quarters, they were a bit higher in this quarter in the U.K. I was wondering what drove those higher costs and how do you see that developing, at least the cost as a percentage of revenue?

[Linda Jane McCurdy, President, CEO & Director]

So what I would say there is Fishers had a great January and February and was significantly hit by the drop in revenue in mid-March harder. And was slightly more difficult to wind down on an escalated path than we saw in Canada. The other differential is that as we own the linen, when it comes back to us, we wash it, put it in storage. And we're incurring the cost of that process without revenue coming in, whereas on the Canadian side, when it's our -- not our goods, we wash it, send it back and bill it.

[Endri Leno, Associate]

Okay. And the last question for me, just a little bit more color on the CapEx in Q1. Just a bit higher than last year. I mean, again, what drove it? If you want -- I mean, was it perhaps the same kind of linen cost? And how do you see CapEx for the rest of 2020?

[Linda Jane McCurdy, President, CEO & Director]

Higher in Q1 only because as we looked and provided guidance of the $5 million last year, the planning was such that much of it would be done in Q1. And that was just say, a planning. We wanted the various projects completed in Q1, with the view that our enterprise-wide system would be rolled out in the back half of 2020. So really that's all there is to that. We have guided that we have delayed that. So believe that we will come in around the $3 million mark for CapEx as it's just not practical at this time to embark on the roll-out of an implementation of a new IT system.

[Operator]

Your next question comes from the line of Michael Glen with Raymond James.

[Michael W. Glen, Equity Research Analyst]

Just maybe the tax rate for the full year that we should guess?

[Kristie L. Plaquin, Chief Financial Officer]

It would be consistent with what you're seeing in Q1.

[Operator]

And I'm not showing any further questions that are in the queue at this time. I will turn the call back over to Kristie Plaquin for any closing comments.

[Kristie L. Plaquin, Chief Financial Officer]

Well, I just want to thank everyone for joining us today, and we look forward to speaking to everyone at our Q2 call.

[Operator]

And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.