K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2021-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the K-Bro Linen Systems Inc. First Quarter 2021 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to hand the conference over to 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 first quarter 2021 results conference call. On the line with me today is Linda McCurdy, President and Chief Executive Officer. Following our remarks today, we will open it up for questions.I'd like to remind everyone that the 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 were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information. Investors are also cautioned not to place undue reliance on these statements. Actual results could differ materially from those anticipated. Risk factors that are -- that could affect the results are detailed in the corporation's public filings.I'll now turn the call over to Linda, who will provide her insights and remarks in 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 of 2021. I'll focus on the first quarter highlights and our outlook for the year, Kristie will then provide more details on our financial performance and our balance sheet.So in terms of the highlights, I'm very pleased with our first quarter results with adjusted EBITDA of $7.8 million and improvements in the adjusted EBITDA margin despite continuing to operate in a very difficult environment as new restrictions were implemented in Canada and the U.K. as the result of COVID. We're very pleased with our record healthcare revenues in Q1 EBITDA.Throughout the pandemic, our teams have moved very quickly to safely meet the changing needs of our customers and it's really this performance that reflects the resiliency of our business model and responsiveness of our team. Our healthcare revenue continue to be strong for Q1 2021. We saw an increase of 23% over Q1 2020 and 26% over Q1 2019. These increases are coming from price increases, temporary services provided in certain markets, product conversions, usage change practices, and increased demand for certain items because of COVID.Since March -- mid-March of 2020, we've seen significantly reduced hotel occupancy rates compared to historical levels. Demand for both business and leisure airline travel has declined significantly on a global basis and airlines have responded with significantly reduced international and domestic flights. Accordingly, hospitality volumes in all of our Canadian and U.K. markets have slowed to historically low levels. While we saw improvement in the corporation's hospitality business in Q3 2020 resulting from increased domestic tourisms, volume in Q4 2020 and in Q2 -- Q1 2021 have decreased, primarily a result of the additional waves of COVID and reinstatement of restrictions.We remain well-positioned from a balance sheet and liquidity perspective with $61.4 million of additional borrowing capacity on our revolving line of credit and with an additional $25 million accordion for growth purposes. Total debt decreased in the quarter from $40.7 million to $36.8 million and our funded debt to EBITDA at the end of Q1 remain conservative at just under 1 time.I'll now take a moment to update everyone on the situation with Alberta Health Services. In October 2020, AHS issued a request for proposal for linen services which encompass the linen services we currently provide to AHS under the AHS Calgary contract as well as the linen services we currently provide to AHS in Edmonton, as well as volumes throughout the remainder of the province, including rural and urban centers. The Calgary and Edmonton volumes are under contract as part of 2 existing agreements until 2022 and 2023 respectively.On April 27, 2021, K-Bro was awarded all the volumes in the RFP. For greater clarity, this award renews all of our existing business in Edmonton and Calgary as new volumes -- as well as new volumes for other rural and urban locations in Alberta. Currently, we process approximately 70% of AHS's volume. As part of the award, we anticipate that volumes will increase through the addition of new sites. However, the terms of the new contract remain subject to negotiation and additional details will be provided once the new contract is entered into. And as we are in the midst of this negotiation process for confidentiality and competitive reasons, we are not able to respond to any questions as it relates to the process or to the RFP award.I will now turn it over to Kristie to discuss our detailed financial results for the quarter, after which I'll return to talk about our outlook for 2021. Kristie, over to you.

[Kristie L. Plaquin, Chief Financial Officer]

Thank you, Linda. The information we are discussing today is also highlighted in our first quarter end 2021 earnings press release which we issued yesterday and detailed supplemental financial information can be found on our Investors Relation website under the heading Financial Documents.For the 3 months ended March 31, 2021, K-Bro's consolidated revenue decreased by 16.9% to $47.6 million from $57.3 million in the comparative period. This decrease was primarily due to the significant reduction in hospitality revenue related to the pandemic. In 2021, approximately 90.4% of K-Bro's consolidated revenue was generated from healthcare institutions, which is higher compared to 61.2% in 2020. This again is primarily related to the pandemic's effect on the Hospitality segment.Consolidated EBITDA increased in the year to $10.1 million from $3.7 million in 2020, which is an increase of 168.8%. The consolidated EBITDA margin increased to 21.1% in 2021 compared to 6.5% in 2020. Consolidated adjusted EBITDA increased in the year to $7.8 million from $7.1 million in 2020. The consolidated adjusted EBITDA margin increased to 16.4% in 2021 compared to 12.4% in 2020.Net earnings increased by $5 million from a loss of $3.4 million in 2020 to $1.6 million in 2021, and net earnings as a percentage of revenue increased to 3.4% in 2021 from negative 6% in 2020. The change in net earnings is primarily related to the flow-through items in EBITDA we mentioned earlier, lower finance costs related to the revolving credit facility, and higher income tax expenses.Wages and benefits in the first quarter of 2021 decreased by $5.2 million to $17.5 million compared to $22.7 million in the comparative period of 2020, and as a percentage of revenue decreased by 2.9% to 36.7%. The decrease as a percentage of revenue is primarily related to improvements in labor efficiencies, $0.4 million received in government assistance in the Canadian division, and is offset by escalating minimum wage rates.Linen in the first quarter of 2021 decreased by $0.6 million to $6.1 million compared to $6.7 million in the comparative period of 2020, and as a percentage of revenue increased by 1.1% to 12.8%. The increase as a percentage of revenue is primarily related to the higher proportion of healthcare revenue. Utilities in the first quarter of 2021 decreased by $0.8 million to $2.8 million compared to $3.6 million in the comparative period of 2020, and as a percentage of revenue decreased by 0.3% to 5.9%. The decrease as a percentage of revenue is primarily related to lower commodity costs.Delivery in the first quarter of 2021 decreased by $2.4 million to $4.6 million compared to $7 million in the comparative period of 2020, and as a percentage of revenue decreased by 2.6% to 9.7%. The decrease as a percentage of revenue is primarily related to government assistance received in addition to management's efforts to offset the impact of the pandemic in the delivery operations of each plant through temporary reductions in the delivery labor force, logistics and delivery route optimizations offset by fixed cost which remain constant regardless of the volumes from COVID, and price increases from renewals of our outsourced freight contracts.Occupancy costs in the first quarter of 2021 decreased by $0.3 million to $0.9 million compared to $1.2 million in the comparative period of 2020, and as a percentage of revenue decreased by 0.2% to 1.8%. The decrease as a percentage of revenue is primarily related to property tax concessions received in certain plants in the U.K.Materials and supplies in the first quarter of 2021 decreased by $0.3 million to $1.8 million compared to $2.1 million in the comparative period of 2020, and as a percentage of revenue, remained constant at 3.7%. The decrease in costs is the result of the reduction in volume resulting from the pandemic offset by additional personal protective equipments required as the result of the pandemic. Repairs and maintenance in the first quarter of 2021 decreased by $0.5 million to $1.7 million compared to $2.2 million in the comparative period of 2020, and as a percentage of revenue decreased by 0.2% to 3.6%. The decrease as a percentage of revenue is primarily related to the timing of maintenance activities.Corporate costs in the first quarter of 2021 decreased by $0.4 million to $2.2 million compared to $2.6 million in the comparative period of 2020, and as a percentage of revenue remained constant at 4.6%. The decrease in costs is related to the timing of initiatives to support the corporation's growth and business strategies across the plants as well as government assistance received.Now looking at our capital resources. Distributable cash flow for the first quarter of 2021 was $5.4 million and our payout ratio was 59.5%. In addition, the company paid out $0.3 per share in dividends during the quarter for total consideration of $3.2 million. The corporation had net working capital of $25.4 million at March 31, 2021, compared to its working capital position of $27.9 million at December 31, 2020. The decrease in working capital is driven mainly from the impact of the pandemic and timing of payments as well as the timing of income taxes payable. At March 31, 2021, total assets decreased to $316.1 million compared to $323.8 million at December 31, 2020, and total liabilities decreased to $127.8 million from $134.3 million.Shareholders' equity decreased at March 31, 2021, from December 31, 2020, to $188.3 million from $189.5 million. As far as our debt is concerned, we have sufficient room on our credit facility with an operating line of $100 million and a further $25 million accordion for growth purposes. As of the end of Q1, we had an undrawn balance of close to $61.4 million reinforcing our strong liquidity. Debt to total capitalization for the period ended March 31, 2021, was 16.4%. Total debt decreased in the quarter from $40.7 million to $36.8 million and was primarily due to changes in working capital as well as cash flow from operations. As Linda said earlier, our debt to EBITDA ratio was just under 1 time.I'll now turn things back over to Linda for additional commentary. Linda?

[Linda Jane McCurdy, President, CEO & Director]

Thanks, Kristie. As we continue to navigate through the pandemic-related challenges, we are very pleased with how quickly we were able to adapt to this unprecedented crisis. In order to address the adverse effects of the pandemic, we had to quickly react to implement plans to mitigate the effects including consolidating operations, reducing headcount, and accessing available government assistance programs. Our highly experienced teams have been crucial in managing the situation and in combination with our proven operating model, we will continue to leverage our experience for the challenges ahead. These actions have resulted in performance that we're quite pleased with given the circumstances.In terms of our 2021 outlook, we continue to see strong results in our Healthcare segment and expect that to continue as hospitals deal with the impact of the pandemic and continue to catch up with the backlog of procedures that have been delayed during the pandemic.As I mentioned earlier, to date in 2021, healthcare revenue for Q1 is trending upward from 2019 historical rates for -- historical rates by approximately 26% although we do expect this increase to be more comparable to Q3 and Q4 of 2020 for the upcoming quarters. From a hospitality perspective, we saw significant year-over-year reductions for Q4 2020 and for Q1 2021 as governments put restrictions in place with the new waves. And as we continue to move into 2021, we believe it is reasonable to expect a modest improvement in client activity for our Hospitality segment, when compared to 2020 activity levels due to a gradual return to business and international travel as COVID restrictions implemented in both Canada and the U.K. began to ease with the rollout of the vaccine. On this note, with restrictions in the U.K. being lifted starting next week, we're optimistic that we'll have a meaningful improvement in client activity in the U.K. commencing in June.While client activity on the hospitality front is still well below historical norms, the increases we've experienced since Q2 2020 have resulted in the reopening of all of our operations with the exception of our Perth plant in Scotland, as well as increasing the days and hours of operations in all of our plants. We've successfully recalled employees to meet increased demands and will continue to adjust production schedules as demand warrants.We remain well-positioned from a balance sheet and liquidity perspective as Kristie discussed, in addition, a strong concentration of our Canadian revenues from the healthcare sector at approximately 87%. We'll continue to evaluate 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 2021 when current market conditions may lead to opportunistic situations for us.So I would say the main highlights of the quarter would be solid financial performance in an unprecedented adverse environment, improvements in EBITDA margin, strong cash flow generation, and a demonstrated resilience of our business model. Again, we're pleased with our record healthcare revenues in Q1 EBITDA.We're also very pleased to have the opportunity to expand our long-term relationship with Alberta Health Services. We began processing healthcare volume in Alberta in the 1980s and we've worked closely and collaboratively with AHS over the past 30 years to earn their confidence and trust. We're happy that we'll continue to provide service for all of our existing customers in Alberta, while also being awarded new healthcare volume. And finally, I'm very proud of our employees who have demonstrated continued flexibility and an unwavering commitment to providing essential services to our customers.I'll now turn it over to answer any questions you have with regards to the first quarter.

[Operator]

[Operator Instructions] Your first question is from Derek Lessard of TD Securities.

[Derek J. Lessard, Research Analyst]

Linda and Kristie, just a quick question. It looks like you -- or it seems like you've kept a tight control of your costs. Just wondering if there's been any inflationary pressure that you've seen on your cost structure lately and maybe some of the steps you're taking to mitigate it.

[Linda Jane McCurdy, President, CEO & Director]

I think our biggest worries going forward, not that we've seen them to date is on the labor front. Again, hospitality volumes have remained weak for Q4 and Q1. We do expect that to change starting with Scotland and England from our Newcastle plant starting pretty imminently here, and our ability to bring back our staff and pressures on wages I think will be our concern. Again, we haven't experienced that to date and certainly, in the U.K. and in Canada, we have our employees coming in for reduced hours.So we are in good touch with them but we're always a little nervous as volumes ramp up, that they will be available or desire us of coming back. But to date, fingers crossed that things continue. We haven't seen a significant amount of pressure on other key input costs, for example, linen which is probably our largest outside of -- well, it is our largest with utilities being our next largest cost outside of labor. We haven't felt the pressure on linen. We do have long-term contracts with suppliers, so we're locked in on that front. And we are hearing some rumblings of plastic and resin prices increasing. Having said that, again, we are under contract and from the overall scheme of our cost structure, it is a fairly small input cost relative to total cost.

[Derek J. Lessard, Research Analyst]

Okay. That's very helpful. And I know you touched on in your opening comments, but obviously, the U.K. is a little bit more advanced in the rollout -- in their vaccine rollout than Canada is. Wondering if you've seen at least any early indications whether it be hotel bookings or tourism indicators to maybe just let us know if there is some light at the end of the tunnel.

[Linda Jane McCurdy, President, CEO & Director]

Yes, so I mean, listen. We know that March -- sorry, April is very consistent with Q1. I would say that in the last -- and it is really premature because it is such a short period of time. I'd say in the last 10 days, we've certainly seen some green sprouts that make us optimistic as well as the fact that the restrictions are absolutely being reduced starting the end of May.So with that, we're optimistic that that's going to translate. Sometimes bookings are a bit of a -- are misleading because while there may be more bookings, because of the flexible cancellation policies that have been in place for some period of time, bookings don't always translate into increased business but I do believe that with the loosening of the restrictions and some of the increased volume we've seen in the U.K. in the last 10 days, we're feeling that it's certainly moving in the right direction.

[Operator]

Your next question is from Michael Glen of Raymond James.

[Michael W. Glen, Equity Research Analyst]

Linda, maybe just to start, congratulations on Alberta, and as you look forward through other parts of Canada, you don't have to get into specifics here, but is there any movements that you see happening in terms of some of the other publicly-owned laundries that you could see some other opportunities on the horizon?

[Linda Jane McCurdy, President, CEO & Director]

What I'll say to that is the trend lines are absolutely moving in the right direction. And to your point, I'm not going to list specific opportunities, but I do believe that the pandemic will accelerate existing trends that we have seen. And we know across the country there is aging infrastructure, we've provided and assisted in a number of areas. And if you look at Alberta as a bit of a proxy where for a large number of years, we provided backup service to many of the rural sites and urban centers. And I think Alberta actually taking the step to outsource, like Saskatchewan did their entire province is a really good fact pattern as other regions look at their options. So I would say that nothing is imminent, but I do believe over the next number of years, additional opportunities within Canada for outsourcing will be on the table.

[Michael W. Glen, Equity Research Analyst]

Okay. And then just going back to the healthcare growth in the quarter. Last -- in Q4, you were able to give us a bit of a breakdown in terms of how to think about that number across the buckets, are you able to give something similar at this time?

[Linda Jane McCurdy, President, CEO & Director]

Yes, sure, absolutely. So because we're comparing to 2019, there would be another year of inflation or price increases. So the price increase bucket is about 6%, temporary service is about 3%, and increase in volume is about 16%, Michael. And in increased volume, there is conversions in that. So of that 16%, I'd say about 3% of that is permanent conversions from disposable.

[Michael W. Glen, Equity Research Analyst]

And the balance being COVID -- kind of COVID-related work that might reverse or go away in the future?

[Linda Jane McCurdy, President, CEO & Director]

So I would say the COVID is the increased volume of 16%. Some of that -- outside of the conversions, some of that will go away in the future and some of it will stay. It's really hard to tell what that -- the breakdown of that will be.

[Operator]

Your next question is from Endri Leno of National Bank.

[Endri Leno, Associate]

A couple for me, actually. The first one, and just following up from the previous question, but some of the temporary volumes that you talked about Linda in the healthcare, I mean what are you seeing there, do you see any willingness from this healthcare system to make them permanent, are there any talks or any RFPs there, do you have any color on that?

[Linda Jane McCurdy, President, CEO & Director]

So what I would say is the larger opportunities from those temporary services are going to take time. It's not going to be an immediate closure and it will take a process. Again, I think that it is a good fact pattern and makes healthcare executive look at what their options are going forward. So I would say we just have to be patient and realize that it's not going to happen overnight but it does give people pause to look at what their alternatives would be going forward. And I would also state it's still really hard in COVID to get traction on initiatives such as that.

[Endri Leno, Associate]

Understood. Thank you. One more from me, it's more on the hospitality side. If you look at the U.K. starting to open up and I mean, the question actually where I'm coming from is that okay, well, sure, hospitality travel all will come back at some point, it's just a question I'm not sure anybody knows when or in what shape or form especially on the international side. Have you given any thought at least in Canada on potentially keeping the same mixture of business that you have right now, perhaps focusing a little bit more on the healthcare and perhaps kind of divesting some of the facilities that are hospitality only? I mean given -- and you're doing quite well I mean with results, I mean, good margins and good results as is. So any thoughts there at all?

[Linda Jane McCurdy, President, CEO & Director]

Listen, here's what I would say is that our ability to service the hospitality sector nationally in Canada is an important fact or an important offering of our service. Our relationship with Avendra, part of their attraction to K-Bro is we truly are the only player who can service hotels in Canada nationally. So really there is no thought process to not provide that service across the country. I don't think that the fact that we provide service to that sector means we don't focus in a meaningful or in a very focused way on the healthcare business, I think we focus on both and both are very good and profitable pieces of business. We certainly are feeling the impact on the hospitality side, but I don't think there is consideration for not being in that sector at all or that segment of the hospitality business.

[Operator]

[Operator Instructions] Your next question is from Justin Keywood of Stifel GMP.

[Justin Keywood, Director of Equity Research]

Just on the indications, you're seeing out of the U.K. as far as bookings, any idea on what the occupancy rates are trending at?

[Linda Jane McCurdy, President, CEO & Director]

Again this is a little crystal ball-ish and it's our management's best estimates, but our hope is that we'll be 50% to 60% of historical norms. That determination is coming from the experience that we saw last summer, it's coming from our relationships with our key customers and what they're seeing with some caveats that bookings don't always translate into paid hotel room nights. So that's kind of what we're hoping for or expecting, Justin, somewhere between 50% to 60% of historical norms.

[Justin Keywood, Director of Equity Research]

Thank you. And as comparison, what were the occupancy rates at this time last year?

[Linda Jane McCurdy, President, CEO & Director]

This time last year, we were down to like 10% of historical norms because really, it was just the beginning of the pandemic.

[Justin Keywood, Director of Equity Research]

And throughout the summer last year because I know there was some increased domestic tourism?

[Linda Jane McCurdy, President, CEO & Director]

Yes, I would say that it was about between 40% and 50%.

[Justin Keywood, Director of Equity Research]

Okay. So improving from last year. And I also know that there is speculation that there could be increased travel between Europe and the U.S. Have you been seeing any of that at all as far as further out bookings or hard to tell?

[Linda Jane McCurdy, President, CEO & Director]

Really hard to tell. What I will say and I did caveat earlier on in my comments, in the last 10 days, we have seen a meaningful pickup in the U.K. which is positive. We view that as quite positive given that the restrictions haven't really even been lifted.

[Justin Keywood, Director of Equity Research]

Okay. Thank you. And then just my last question. If I recall, prior to the pandemic, U.K. or Fishers was that around 15% of K-Bro's overall revenue?

[Linda Jane McCurdy, President, CEO & Director]

Little higher than that, Kristie, right?

[Kristie L. Plaquin, Chief Financial Officer]

Yes. Slightly higher than that.

[Justin Keywood, Director of Equity Research]

Okay. That's all for context.

[Linda Jane McCurdy, President, CEO & Director]

In the ballpark, Justin, but slightly higher.

[Operator]

Your final question is from Kyle McPhee of Cormark Securities.

[Kyle McPhee, Analyst of Institutional Equity Research]

On your EBITDA margins, you've been posting big gains year-over-year for many quarters that percentage margin picking way up. Can you help us better understand what the biggest drivers there are, and more importantly, when we fast forward to the post-COVID world, should your margins be landing higher than we saw back in years like 2017, '18, '19 when I think there was a lot of noise impacting your margin. So maybe even land back to kind of 2015, '16 levels and at that 19%-ish level before IFRS, is that a fair directional type outlook for your normalized margins?

[Linda Jane McCurdy, President, CEO & Director]

Yes, I think that's -- you've summarized it quite well. Obviously, in the years where we were doing infrastructure builds, new plant builds, and transitioning volumes, we saw an impact on -- a negative impact on our margins. As we've become and fine-tune those new plants and gotten the efficiencies in those plants, we've seen an improved -- efficiencies through improved productivity as well as reduced utility consumption, we've seen positive impacts on our margins.I'd say it's a fair range -- a fair EBITDA margin range of 19%. The -- it will depend how quickly hospitality comes back and it will also depend on what impact that has on the additional volume we're getting from healthcare as well. So there's a few moving parts there but I would say that throughout the pandemic, it has enabled us to ensure that we've eked out all our productivity gains in our new plants, which has taken some time since we've built them.

[Kyle McPhee, Analyst of Institutional Equity Research]

Got it. Thanks for that color. And last one from me on the labor front. Given your worries that you might not be able to actually procure the labor you need as hospitality volumes ramp back up, I know there's some headlines in the U.S. about shortages. And related to that, would you potentially opt to bring back labor before the volume even shows up maybe triggering kind of a temporary margin issue? Any color there would be helpful.

[Linda Jane McCurdy, President, CEO & Director]

Again, what we have really tried to do in both the U.K. and Canada is have revolving layoffs. So what that means is that we have been in contact with all of our employees and we have -- we feel we have a good handle on who is available to come back on a full-time basis, because they're working part-time or they're working on rotating shifts over a 4-week period. The unknown to us is as other businesses ramp-up will they opt for other employment opportunities versus us where we hear a lot about people not wanting to go back to work in the U.S. because of hefty government subsidies.Because we see our employees coming back to work, albeit on a much reduced hourly -- fewer hours per week, they are coming back to work. So I'm not saying that we're not worried about it but at this point, we know who is available to come to work and then it'll just be who when things open up will they opt for a different job versus coming back to K-Bro permanently and on a full-time basis.

[Operator]

At this time, there are no other questions in queue. Do you have any closing remarks?

[Linda Jane McCurdy, President, CEO & Director]

No. Want to thank everyone for their interest today and if there's any further questions, please don't hesitate to follow up with Kristie and I. Everyone have a great day and we'll talk again soon.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.