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K-Bro Linen Inc
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Good morning, my name is Julie, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the K-Bro Linen Systems Second Quarter Results Conference Call. [Operator Instructions] Please note that today's call is being webcast live and will be archived for replay, both online and by telephone, beginning approximately 2 hours following completion of the call.I would now like to turn the call over to Kristie Plaquin, Chief Financial Officer of K-Bro Linen. You may begin your conference.
Thank you, operator, and good morning, everyone. Thank you for joining us today, and welcome to our 2018 Second Quarter Conference Call. On the line today with me is Linda McCurdy, President and Chief Executive Officer. Before I turn the call over to Linda, 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 were applied in drawing a conclusion or making a forecast or projection as 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, which is available on SEDAR or our corporate website.With that, I'll now turn the call over to our CEO, Linda McCurdy.
Thank you, Kristie. Good morning, everyone, and thank you for joining us today. We had a strong second quarter with a 50% increase in revenue compared to the same quarter last year with Canadian revenues up 10.3%. The growth in revenue comes mainly from Fishers in the U.K. as the tourist season got underway during the quarter, driving an increase in activity in the hospitality segment. [ Seasonality ] of Fishers revenue was demonstrated during the quarter along with its weighting towards the hospitality sector. Also demonstrated was the fundamental value of the acquisition through Fishers' meaningful contribution to our topline. Fishers has provided us with a strong market position in the U.K., including solid partnerships with new [ and existing ] customers.As our first foray in international market integration of the company has gone very well and is essentially [ complete ]. Although we still expect to gain efficiencies [Audio Gap]businesses.Second quarter revenue also benefited from gains in volume in the healthcare segment, mainly the Canadian market, including newly awarded contracts incremental volumes from existing customers and adding new customers in existing markets. On a consolidated basis, the relative proportion of healthcare to hospitality revenue as a percentage of total revenue for the quarter was 58% healthcare to 42% hospitality. This again reflects contributions from Fishers and the seasonality of the hospitality segment.During the quarter, we signed a definitive agreement to acquire Linitek, a private laundry and linen service company out of Calgary, Alberta. Total consideration of the acquisition [ is ] $4.7 million and is expected to add approximately $3.5 million in incremental revenue and $0.6 million of incremental EBITDA annually. The acquisition is immediately accretive and strengthens our position in a very strong market.We expect the acquisition will close in October 2018, and we look forward to bringing their operations [Audio Gap]the K-Bro fold.As Kristie will allude to throughout her financial review, we continue to [ spend ] significant capital towards our new state-of-the-art Vancouver facilities. As of June 30 of this year, we had incurred $49.1 million of the total expected capital cost of $55 million, with $4 million incurred during the second quarter of this year.Along with the new facility, we are upgrading and replacing equipment at another Vancouver area facility. Late in Q2, we began the transition from the older facility into the newly renovated facility and completed the second transition during the month of July. As a result of the transition and[Audio Gap]investment to existing equipment and facilities, EBITDA margins for the second quarter were compressed, and we expect that compression to [ continue for ] the remainder of the year and into 2019 as transition costs associated with the Vancouver facility persist. Staffing the facility has been the biggest contributor to time and cost, simply by not having sufficient bodies to fully optimize the facility. However, at the end of this investment and transition cycle, we will benefit from a fully efficient and modernized[Audio Gap]asset base. We will also come to the end of our largest capital spending program. A program that we have been committed to for the past 2 years, and we expect to return to normalized EBITDA margins similar to annual performance achieved [ in ] 2015[Audio Gap]expect to do so in 2019.I'll now turn the call over to Kristie to [ address ] our financial results for the quarter, after which I'll return to talk about what we expect to accomplish for the remainder of the year, and how we're thinking about the business long term. Kristie?
Thank you, Linda. As Linda just mentioned, I will provide a summary of our consolidated results for the second quarter. The information discussed is also highlighted in our 2018 second quarter earnings press release issued yesterday. Detailed supplemental financial information can be found on our investors relations website under the heading Financial Documents. Again, as Linda mentioned, revenue for the quarter increased by 50% compared to the same period last year with Fishers contributing $16.1 million towards consolidated revenue of $60.7 million for the quarter. In addition to Fishers, we benefited from gains in additional awarded healthcare volumes from the Vancouver lower mainland contract and Trillium Health Partners volume in the Toronto market, organic growth from existing customers and new customers in existing markets. The distribution of revenue generated from healthcare compared to hospitality for the quarter was 58.2% to 41.7%, respectively. This compares to 70.4% healthcare to 29.6% hospitality during the second quarter last year. The shift in distribution reflects the Fishers acquisition with the majority of its business focused on the hospitality sector. EBITDA increased to $8.5 million or 27% over the second quarter last year and year-to-date, increased to $14.7 million or nearly 30% compared to the same period last year.Growth in EBITDA was a result of an increase in hospitality volume during the quarter, which were predominantly driven by Fishers, along with efficiencies gained at our Toronto facility, specifically through investing in new and upgraded equipment to reduce operating and utility cost, putting downward pressure on EBITDA for costs associated with the transition to our new Vancouver facility, along with minimum wage increases in Canada that have not yet been reflected in pricing. We estimate the costs associated with the Vancouver transition during the quarter were approximately $2 million. Consolidated EBITDA margin decreased to 14.1% for the quarter compared to 16.4% for the same quarter last year.As we continue to transition operations in Vancouver to our new facility, downward pressure in EBITDA margin will persist, and we anticipate that the first half of 2019 will still be impacted to some extent as the Vancouver plants gain efficiencies. However, as we near the end of what we view as an essential long-term investment in our facilities, we expect that by mid-2019, annualized EBITDA margins will return to levels achieved in 2015.Net earnings for the quarter increased to $2.6 million or 10.6% compared to the second quarter last year and year-to-date, decreased to $3.2 million or 9.9%.The decrease in net earnings year-to-date is largely a result of the flow-through items in EBITDA that we discussed earlier, along with higher finance costs related to our revolving credit facility and higher depreciation associated with new plant builds. All of these factors were offset by a slightly lower income tax expense.Looking at the operating expenses for the quarter, wages and benefits increased to $24.7 million or 49% compared to the second quarter last year. Year-to-date, they increased to $48.1 million or 46%. The increase is largely due to incremental labor needed to process higher volumes over time and onetime costs related to the Vancouver transition and again, increases made to minimum wage in Canada. Linen expenses during the quarter increased to $6.8 million or 51% over the second quarter last year. Year-to-date, they increased to $13.2 million or 48% compared to the same period last year. The increase in linen expense was mainly related to our U.K. division but also included linen costs associated with increased healthcare volumes from new customers in Canada.Utility costs increased to $3.5 million or 52% compared to the same quarter last year and year-to-date, increased to $7 million or 40% compared to the same period last year. The increase was largely a result of costs related to our U.K. division in addition to incremental volumes processed and higher carbon levy rates in Alberta. These costs were partially offset by improved efficiencies of the new Toronto facility. Delivery costs for the quarter increased to $7.4 million or 80% compared to the second quarter last year. Year-to-date, they increased 78% compared to the same period last year. Again, the increase was a result of the cost associated with Fishers, with the remainder of the increase a result of increased business activities, measures put in place to address temporary capacity constraints in our Vancouver facility, higher carbon levy rates in Alberta and higher cost of diesel and external freight charges associated with diesel price.Occupancy costs increased to $2.5 million or 47% for the quarter compared to the second quarter last year and to $4.8 million or 55% year-to-date when compared to the same period last year. Largely as a result of costs associated with Fishers, the increase also reflects costs related to the new Toronto facility and the new Vancouver facility. Materials and supplies for the quarter increased to $2 million or 67% compared to the second quarter last year. Year-to-date, the expense increased to $4 million or 48% over the same period last year. Again, the bulk of the increase was tied to Fishers but also is a result of onetime setup costs as part of the Vancouver transition.Repairs and maintenance in the second quarter increased to $2.3 million or 92% compared to the second quarter last year and year-to-date, increased to $4 million or 58% compared to the same time frame last year. Scheduled maintenance activities and onetime costs related to the Vancouver transition led to the increase. For the quarter, corporate costs increased to $3 million or 26% compared to the second quarter last year. Year-to-date, they increased $5.5 million or 20% compared to the same time frame last year. Changes in corporate costs are largely a result of the timing of costs and initiatives to support the company's growth and business strategies, in particular, costs incurred with respect to the acquisition of Linitek, along with the acquisition of Fishers. Overall, corporate cost decreased as a percentage of revenue year-over-year.Now looking to our capital resources. For the 6 months ended June 30, 2018, distributable cash flow was $11.7 million, and our payout ratio for the second quarter was 48.8%. We continue to manage our distributable cash flow to balance CapEx requirements, working capital and growth capital, with stable and reliable dividend payments to our shareholders. Year-to-date, the company has paid out $0.60 per share in dividends for total consideration of $6.3 million. Debt to total capitalization for the 6 months ended June 30, 2018 was 26.8%. This has increased 18.4% at December 31, 2017, reflecting an increase in capital expenditures related to the new Vancouver facility.Net working capital at June 30 was $46.6 million compared to $32 million at December 31, 2017. The increase is due to timing related to the cash settlement of new plant equipment, timing of income tax recovery, the seasonality of hospitality volume processed at Fishers and deposits related to the acquisition of equipment related across the plants.At June 30, 2018, total assets increased to $317.1 million compared to $295 million at December 31, 2017, and total liabilities increased to $116 million from $93.6 million. Shareholders equity decreased at June 30 from December 31, 2017 to $201.1 million from $201.6 million.Overall, second quarter results were more -- were most effective -- most affected by contributions and operating costs associated with the Fishers acquisition, along with onetime costs related to the Vancouver transition. While these costs have impacted our margins in the near term, we believe that the company is positioned for the long-term sustainable growth and a return to historical margins.I'll now turn things over to Linda to further talk about what we can expect for the remainder of the year, our market outlook and long-term strategy.
Thank you very much, Kristie. We have spent the good part of 2 years making significant capital investments in our business, completing upgrades and refurbishments to existing facilities and equipment and building brand-new facilities in Vancouver and Toronto, 2 of Canada's largest cities and 2 of our largest markets. We have been strategic in our capital spending, and as we transition out of investment mode into growth mode, we occupy a unique competitive position in the market.Our facilities are modern and efficient with recent improvements focused on reducing natural gas and water usage, increasing automation through new equipment and system designs, which leads to reducing operating costs and allows us to pass cost savings on to our customers. We have the size and scale to service and grow in all of the markets we operate.In the U.K., we have seen renewed interest in the Fishers brand as both existing and potential customers get to know K-Bro. With Fishers' experienced local management team paired with K-Bro as a large market-leading operator in North America, we've been able to demonstrate that we run our operations on a large scale and can be a strategic partner in both the hospitality and healthcare sectors.As with all of our businesses, our near-term priorities are to renew all of our key contracts and secure new business, along with further integrating Fishers into the K-Bro model.There is opportunity to increase market share in the U.K., particularly in healthcare. As has been noted by several analysts, healthcare laundry in the U.K. is quite disparate between Scotland and England. It remains in-house in Scotland whereas in England, it is largely outsourced. That represents near-term opportunity in England and if and when Scotland shifts towards outsourcing laundry and linen services as most of England, Europe and North America has already done. In the meantime, we will continue to be a market leader in hospitality.In Canada, across 5 provinces, our facilities are located in all major markets, all with unutilized capacity to quickly and efficiently add volume and increase market share. The new Vancouver facility has started to process healthcare volumes, upgrades to the other facility are -- continue during the quarter, and we have moved all of the hospitality volumes to this location. We have not renewed our lease in the third Vancouver location and expect to be completely out of this facility in the quarter. We are on track to complete the transition in Vancouver by the end of Q3, but again, we will not be fully optimized. We expect to achieve full operational efficiencies in 2019.In Toronto, we have added $7.6 million of incremental healthcare revenue through long-term contracts, while occupying a relatively small share of the market when compared to the rest of Canada, particularly, Western Canada. Commissioning of the new facility has been completed and through our long-term lease of the facility, we can quickly and easily add to capacity as opportunities arise. We continue to see a steady stream of RFPs in the region, indicating to us that there is room to grow our business in Canada's largest city. We look forward to completing the acquisition of Linitek in Calgary and integrating the business into K-Bro's model. We will continue to service existing volumes from their facility in the near term and make the decision to transfer volumes to K-Bro's Calgary facility based on whether or not there is opportunity to realize efficiencies by doing so.Our balance sheet affords us the flexibility to move quickly to grow our business, and we will continue to evaluate acquisitions of any size, whether it's tuck-in or larger strategic acquisitions similar to Fishers. Contract renewals remain a priority, and the pipeline for new contracts and adding to existing contracts continues to be positive.As we have said throughout the call, we're focused on profitable growth for the long term. Going into 2019, we expect annual CapEx for Fishers and K-Bro combined to be roughly $4 million and expect that this will be the case for the next few years. This lower cost structure will help us get back to normalized margins.Thank you for joining us today. And I would like to open up the call now to any questions you might have.
[Operator Instructions] And your first question comes from Lennox Gibbs with TD Securities.
With respect to Fishers, there's a significant sequential uptick in the healthcare segment. Can you provide more detail as to what drove that uptick? That's the first part. And then, secondly, can you speak to the seasonality in Scotland post quarter? So give us some sense as to the kind of summer season they're experiencing. And I guess, what I'm ultimately getting at is whether we should expect a stronger sequential uptick going into the third quarter.
Sure. I'll answer your second question first, Lennox. Obviously, we've seen an uptick in both sales and EBITDA in Fishers as expected in Q2. I would expect Q3 to be stronger than Q2, and Q4 will again be much closer to the Q1. But Q3 and Q4 are substantially stronger than the other 2 quarters, with Q3 being the strongest. We feel good about the performance of Fishers and are on track with expectations there based on the purchase price of GBP 5 million of EBITDA. In terms of your first question Lennox, I just want to make sure I understand. The -- were you asking about healthcare in Scotland?
Yes. If -- it looks as though you did $3.2 million versus $55 million in the first quarter.
Kristie, could -- do you have some thoughts on that?
Yes. Lennox, it has to do with stronger garment revenue in the second quarter, which we would anticipate to move into the third quarter as well.
Stronger garment revenue?
So similar to the [indiscernible] cleanroom revenue.
Oh, it's more so cleanroom?
Cleanroom.
Yes.
Yes, sorry. I -- we call it the cleanroom/garment is the non-hospitality versus healthcare. So a fair point, sorry.
Right, right. So why the uptick? Is that new business or...
No. I would say that's[Audio Gap]business that is stronger in the quarter, Lennox.
So it's just a quarter-to-quarter -- it's just a [ rate ] fluctuation?
Yes. Correct.
Okay. And then, finally, with respect to Vancouver, can you provide more detail regarding the extent of the labor constraints you're experiencing at the newer upgraded facilities as well as some sense as to how you hope to address that challenge?
Yes. So transitioning into the first plant, I think I talked last quarter about the success we were seeing in attracting staff from, geographically a new market, from Surrey. I would say the transition from the older hospitality plant to the upgraded hospitality plant, we have definitely seen more challenges. We're working our way through them through creative recruiting strategies, and we are having some success, but I would say, it has definitely been a challenge for Q3. I think what I can say is we have seen challenges in July, but as we enter into mid-August now, we have seen some more success.
Can you give us a sense as to, let's say, percent completion. How -- like what percentage of the way are you there to the numbers you need to get to?
What I -- I think what I can say to that is that we would expect our onetime cost as the result of the labor challenges to be similar or slightly higher than we saw in Toronto. I would say that, again, we have moved all of the facilities, which is the starting point. A, we moved the first plant, we moved the second plant, we are out completely of the original hospitality plants, and we have staffed them all. We're still continuing to run significant overtime but have made significant progress in August versus July. So it's trending in the right direction, but definitely July was challenging for sure.
Your next question comes from Maggie MacDougall with Cormark Securities.
So you commented in your statements that you're seeing some renewed interest in the Fishers brand, and I thought that was pretty interesting. So I was wondering if you could just elaborate on that statement in terms of what you might be seeing developing that could indicate some potential opportunity for you guys in the future there.
So we have been very aggressive and active in meeting with large group hotels, and we are getting some very positive feedback. We are working to secure some of these large groups. They are very pleased that the Fishers' ownership structure has been settled. They are happy that there has been a strategic acquirer. And I would expect over the next 6 months to 1 year that we will be successful in securing new business as the result of that.
Okay. That's excellent. And then, in terms of opportunities that you may have in Canada that your new expanded capacity in Toronto and Vancouver may allow you to take advantage of in the future, could you just give us a bit of an update on where some of those are? And I understand that you can't really talk specifically to them but perhaps at a high level, what your outlook is?
Sure. I would say that in the Toronto market, we continue to see a healthy stream of RFPs on the healthcare side of the business, and we continue to see strong interest on the hospitality side, where they less formally go through an RFP process. I would say that we still feel fairly confident of our $15 million -- $10 million to $15 million revenue target over the next several years. In Vancouver, I would say that it'll be focused on hospitality and on long-term care, since we do a significant portion of the[Audio Gap]business already. But I will say that we feel pretty good about long-term care and hospitality and our growth prospects there. Probably not as large of an opportunity as the numbers I've given you for Toronto but still, good growth prospects.
Okay. And then just to follow up on the margin discussion for 2019, early 2019 and the end of this year. So I believe that I was modeling some continued margin compression from the Vancouver transition for Q3 easing up a bit in Q4. But it sounds as though, given the labor constraints, that margin compression could just hang on a little longer than you had previously thought. Is that correct in understanding?
Yes. I would say that it will ease in Q4, but it will still exist. It will not be as significant as Q2 and Q3, which will be the heaviest quarters. And I do believe that it'll trail into 2019.
Your next question comes from Endri Leno with National Bank.
A few for me. First of all, I was wondering if you can quantify what the impact of the minimum wage was in the quarter. And how much of this do you expect to be offset by the price step-ups?
So what I would say to that is the difference from 2015 -- I'd say, it's basically about 2%, which has come down from what we've seen in the first quarter and will continue to decrease as time goes on. We saw, obviously, another large step-up in June in B.C., where minimum wage went up. It obviously went up in January in Toronto. In June, it went up dramatically in B.C. I'd say it's about a 2% impact, which will decline as price increases continue to be passed on as contracts come up.
Great. Next question on -- a bit more on Fishers. So I was wondering, I mean, there is all this talk about Brexit, and equipment coming in the U.K. or sourcing different equipment and linen, do you expect any concerns if you need to change anything at Fishers. Or do you have any contingency plans related to that?
The only impact that we anticipate is impact on labor and access to labor from some of the [ east ][Audio Gap]a large contingent of employees who come from outside of the U.K., and access to that pipeline is undetermined at this point. I will say that it'll be something that all service industries will have to face, and we don't really know how that'll play out. As we've continued to see[Audio Gap]pressure in Canada[Audio Gap]access to labor, we will continue to make the right strategic investments to be as efficient as we can. But that would be the one impact that we are continually looking at.
Great. And last question for me. Are you able to quantify the timing and the magnitude of the potential efficiencies from that acquisition in Calgary of Linitek?
So I think what we've disclosed is that we expect a just over a $0.5 million of an EBITDA contribution. Yes, and that's the guidance we've provided there.
Okay. And that's expected to be accreted -- accretive immediately, right?
There'll be some transition into the new -- some transition that would be required, but it'll be far less than anything we see in a Vancouver-Toronto transition just because of the magnitude of the acquisition relative to the size of our existing operations. It will be very -- it'll be short term.
[Operator Instructions] Your next question comes from Justin Keywood with GMP Securities.
On the cash from ops, [ it's not ] an unusual decline in the quarter due to the working capital but I'm just wondering if there is anything particular that led to that. And how we should look at the cash generation over the back half of the year?
Kristie, I'll let you address that.
Sure. Thanks, Justin. I think, Justin, a lot of it is timing-related, and I would anticipate that as we move throughout the year, we turn to a more normalized level. And I wouldn't anticipate that this would be the case going forward.
Okay. Should we expect a big rebound in Q3 or maybe more evenly distributed over the next 2 quarters?
Maybe more evenly distributed between Q3 and Q4.
Okay. And then, on the -- you mentioned the new RFPs you're seeing, particularly on the healthcare side in Canada, I'm wondering, if the new conservative government in Ontario is expected to result in more outsourcing opportunities.
That's a very interesting point and observation. I definitely think that it creates opportunity. It's very early days, but we do -- I do believe that, that opportunity exists. And[Audio Gap]know that we will make every effort to try and push that agenda forward. I will say that it is early days, but I think from an outsourcing perspective, we will be on the agenda at some point.
Okay. And then on the pursuit of new organic business versus growth by acquisition, I'm wondering if there's a preference to pursue one over the other in the near term or how do you manage that. And maybe just some general thoughts on the broader M&A environment that you're seeing.
Justin, I don't think we have a preference, one over the other. What I would say is that so much of it from an acquisition perspective comes down to valuation. Again, we've remained very focused on Canada but also the U.K. And we continue to look at the opportunities out there, but there really is no preference, and I do believe that both avenues will be -- both paths will be avenues for growth.
Your next question comes from Elizabeth Johnson (sic) [ Johnston ] with Laurentian Bank Securities.
Just go back to the Fishers business and results in the quarter, can you give us any sense of how revenue trended in Q2 and if you're able to compare to prior Q2 periods to give us a sense of how that business is tracking year-over-year?
Very consistent to prior year and as we expected, for this year. There are no material year-over-year changes.
Okay. Great. And so I should assume then it seems like the hospitality business ramps in Q2, hitting sort of its stride so to speak in Q3.
Q3 will be stronger than Q2, for sure. Absolutely.
Okay. Great. And I just wanted to clarify one of your previous comment about the wage impact in the quarter. You mentioned it being 2% or so. Was that 2% on EBITDA margin? Is that how I should be thinking about it?
Yes, yes. Sorry. Sorry, if I wasn't clear there, but yes, that's the right way to look at it.
Okay. Great. And again on Fishers, when it comes to hospitality contracts in the U.K., is there any difference with respect to the average length that you're seeing there compared to Canada?
Pretty -- it's pretty consistent. I would say, generally, they're 3- to 5-year contracts, both in Canada and in the U.K.
So no structural differences that you're seeing at least at this point?
Correct.
Okay. Great. And just, I think, question for Kristie in terms of the remaining CapEx. Should we assume this mostly comes in Q3 or more evenly spread in the second half of the year?
More evenly spread in the second half of the year, probably about half in each quarter.
Your next question comes from Brian Pow with Acumen.
I just wanted to follow up on the questions on the working capital. And just looking at it, in particular, sort of the accounts receivable, demand jumped up pretty strongly. Does that relate to Fishers, maybe just timing? Or maybe you can just add some -- a little bit more insight into that larger number.
Yes, yes. Yes, Brian, it certainly does relate to Fishers and the timing of cash receipts, which is why over the balance of the year, we do expect that to reverse.
And should we -- like as we model forward like into 2019, should we expect that kind of demand again? Or is it -- is there something you can do to address it?
I think at this point, I would expect some uptick. I think there are certain things we can do to address it but not in its entirety.
Okay. Great. My second question just again relates to your transition costs in Vancouver. You had about $1 million in Q1 that you had expensed, $2 million in Q2. Just relating to Linda's previous comment that the transition cost would be more than Toronto, can you give us a sense again what the Toronto number was? And -- just to help us understand sort of how it should close out.
[indiscernible]
Sure. The...
Go ahead.
Go ahead Linda. That's fine.
We[Audio Gap]and[Audio Gap]we provided guidance that the transition costs for Toronto were about just over[Audio Gap]about $4.7 million. At this point, I think, we can expect in Q3 the transition cost to be very similar to Q2. And they will tail off quite substantially in Q4, but I think they will be north of $5 million, Brian.
You have no further questions at this time.
Great. Well, thank you everyone for joining us today. And if you have any follow-up questions, please don't hesitate to reach out to Kristie or myself. And we'll talk again soon in Q3.
This concludes today's conference call. You may now disconnect.