K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2019-Q2

[Operator]

Good morning. My name is Kenzie, and I will be your conference operator today. At this time, I would like to welcome everyone to the K-Bro Linen Systems Inc. Second Quarter Results 2019 Conference Call. [Operator Instructions] At this time, I would like to introduce our host, Kristie Plaquin. You may begin.

[Kristie L. Plaquin, Chief Financial Officer]

Thank you, operator, and good morning, everyone. Thank you for joining us today, and welcome to our second quarter 2019 conference call. On the line with me today is Linda McCurdy, President and Chief Executive Officer. I'd 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 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, and good morning to everyone. Thank you for joining us today. The second quarter continues on track with strong results with continued growth and improved operating performance. Overall, from a top line perspective, our revenue grew by 5.2% over the same period last year, benefiting from the Linitek acquisition, which closed in October of 2018 and from organic growth in both our U.K. and Canadian operations. We also made substantial progress in our return to normalized EBITDA margins for our Canadian operations.Before the adoption of IFRS 16, which Kristie will provide further details on shortly, EBITDA increased in the second quarter of 2019 to $10.5 million from $8.5 million for the same period last year. And respectively, EBITDA margin increased to 16.4% from 13.9%, again, before IFRS 16, despite further increases in our cost structure as the result of significant increases in minimum wage in B.C. With the completion of the Vancouver transition, we've exited our major investment cycle and remain focused on refining and improving operational efficiencies. During the quarter, we saw EBITDA growth in Canada before the adoption of IFRS 16 of $2 million or 33.6%, and we saw a margin improvement of 3.5 percentage points.As a result of organic growth from new and existing customers in the hospitality space, the relative proportion of hospitality to health care revenue as a percent of total revenue for the quarter continues to evolve. Our consolidated hospitality segment revenue for the second quarter represented 45.7% of overall revenue compared to 41.7% for the same period last year. We were able to grow hospitality revenue over the same quarter last year by 8.1% in Canada and by 8.9% in the U.K., with consolidated growth of 8.5%. Volumes in hospitality have ramped up in line with seasonal expectations throughout the second quarter, and we expect to hit the segment's seasonal peak in Q3. Our health care segment has also experienced growth. We've grown by 2.5%, which has primarily been from organic growth as well as contractual rate increases.At this point, I'll turn the call over to Kristie to discuss our financial results for the quarter. After which time, I'll talk about the remainder of the year and of course open it up for any questions you might have.

[Kristie L. Plaquin, Chief Financial Officer]

Thank you, Linda. The information we are discussing today is also highlighted in our second quarter and 2019 earnings press release issued yesterday, and detailed supplemental financial information can be found on our Investor Relations website under the heading Financial Documents. Consolidated revenue for the second quarter increased by 5.2% compared to the second quarter last year and 4.8% on a year-to-date basis. The hospitality segment contributed $29.2 million; and health care, $34.7 million; and respectively, on a year-to-date basis, $52.8 million and $68.8 million.For the second quarter, Fishers contributed $17.3 million towards the consolidated revenue of $63.9 million; and on a year-to-date basis, $30.5 million of the consolidated revenue of $121.7 million. The distribution of revenue generated from hospitality compared to health care for the second quarter was 45.7% to 54.3%, respectively, an increase in hospitality revenue compared to the same quarter last year of approximately 8.5%. The adoption of IFRS 16 continues to have an impact on EBITDA. And while we have adopted the new accounting standards retroactive to Jan 1 of this year, we have not restated the comparative periods for 2018. However, we continue to provide a reconciliation of actual Q2 and year-to-date financial results compared to what would have occurred had we not adopted the new policy in the MD&A. EBITDA for the second quarter before the adoption of IFRS 16 was $10.5 million compared to $8.5 million for the same period last year, an increase of 24.1% and, respectively, on a year-to-date basis, was $17.3 million compared to $14.7 million in 2018, an increase of 18%. We saw substantial gains in Canada from operating efficiencies gained on a quarter-over-quarter basis as a result of capital investments made in 2018. The remainder of the increase in EBITDA is due to flow-through of revenue growth as discussed, offset by higher commodity costs in the U.K., higher costs in British Columbia as a result of the temporary natural gas supply shortage during the first quarter, rising minimum wage rates in advance of future revenue price escalators and tight labor markets in both British Columbia and Québec.Consolidated EBITDA margin, once again before the adoption of IFRS 16, increased for the second quarter compared to the same period last year from 13.9% to 16.4%, and on a year-to-date basis from 12.6% to 14.2%. Our Canadian EBITDA margin for the second quarter before the adoption of IFRS 16 was 16.9% compared to 13.2% for the same period last year. And Fishers was 15.1% compared to 15.9% in the prior year. The same quarter, respectively, on a year-to-date basis for our Canadian division was 15.2% compared to 13% in 2018, and Fishers was 11.3% compared to 11.5% in 2018.Net earnings in the second quarter of 2019 increased by $0.9 million to $3.5 million compared to $2.6 million in the same comparative period of 2018, and as a percentage of revenue increased by 1.3% to 5.6% on a year-to-date. On a year-to-date basis, net earnings increased by $0.8 million to $4 million compared to $3.2 million in the same period of 2018, and as a percentage of revenue increased by 0.5% to 3.3%. The change in net earnings is primarily related to the flow-through items in EBITDA, offset by higher depreciation of property, plant and equipment and finance costs on a year-to-date basis of $4.8 million due to the change of accounting policies with the adoption of IFRS 16, higher depreciation associated with new plant builds and the acquisition of Linitek, higher finance costs related to the credit facility and offset by a lower income tax expense. Operating expenses in the second quarter of 2019 decreased by $1.1 million to $51.2 million compared to $52.3 million in the same comparative period of 2018, and as a percentage of revenue decreased by 6% to 80.1%. On a year-to-date basis, operating expenses decreased by $1.7 million to $99.8 million compared to $101.5 million in the same comparative period of 2018, and as a percentage of revenue decreased by 5.4% to 82%. Wages and benefits in the second quarter 2019 increased by $0.2 million to $24.9 million compared to $24.7 million in the same comparative period of 2018, and as a percentage of revenue decreased by 1.8% to 38.9%. On a year-to-date basis, wages and benefits increased by $0.2 million to $48.3 million compared to $48.1 million in the same comparative period of 2018, and as a percentage of revenue decreased to 39.7%. The decrease as a percentage of revenue is primarily related to diminishing onetime costs related to the Vancouver transition when compared to 2018. The overall increase in wages and benefits is related to incremental labor required to process higher volumes, escalating minimum wage rates and tight labor markets in British Columbia and Québec.Linen in the second quarter of 2019 increased by $0.1 million to $6.9 million compared to $6.8 million in the same comparative period of 2018, and as a percentage of revenue decreased by 0.4% to 10.8%. On a year-to-date basis, linen increased by $0.2 million to $13.4 million compared to $13.2 million in the same comparative period of 2018, and as a percentage of revenue decreased by 0.4% to 11%. The decrease as a percentage of revenue is primarily related to a higher proportion of hospitality revenue in the quarter that doesn't require linen replacement.Utilities in the second quarter of 2019 increased by $0.5 million to $4 million compared to $3.5 million in the same comparative period of 2018, and as a percentage of revenue increased by 0.5% to 6.3%. On a year-to-date basis, utilities increased by $1.4 million to $8.4 million compared to $7 million in the same comparative period of 2018, and as a percentage of revenue increased by 0.8% to 6.9%. The increase as a percentage of revenue is primarily related to higher commodity costs in the U.K. related to the timing of contracts and market conditions, higher costs in British Columbia as a result of the temporary natural gas supply shortage during the first quarter, incremental volume processed, offset by improved efficiencies in the new Vancouver facilities.Delivery in the second quarter of 2019 decreased by $0.2 million to $7.2 million compared to $7.4 million in the comparative period of 2018, and as a percentage of revenue decreased by 1% to 11.2%. On a year-to-date basis, delivery decreased by $0.6 million to $14.2 million compared to $14.8 million in the same comparative period of 2018, and as a percentage of revenue decreased by 1.1% to 11.6%. The decrease as a percentage of revenue is primarily related to the adoption of IFRS 16, which accounts for 1.4% and a decrease to delivery costs at $1.8 million. This is offset by increased business activity, price increases from renewals of outsourced freight contracts and higher costs of diesel and external freight charges tied to the diesel price. Occupancy costs in the second quarter of 2019 decreased by $1.4 million to $1.1 million compared to $2.5 million in the same comparative period of 2018, and as a percentage of revenue decreased by 2.3% to 1.8%. On a year-to-date basis, occupancy costs decreased by $2.6 million to $2.2 million compared to $4.8 million in the same comparative period of 2018, and as a percentage of revenue decreased by 2.3% to 1.8%. The decrease as a percentage of revenue is primarily related to the adoption of IFRS 16, which accounts for 2.3%, and a decrease to occupancy costs of $2.7 million. This is offset by costs associated with the acquisition of Linitek and higher rent costs at our new Vancouver facility. Materials and supplies in the second quarter of 2019 decreased by $0.1 million to $1.9 million compared to $2 million in the same comparative period of 2018, and as a percentage of revenue decreased by 0.3% to 3%. On a year-to-date basis, materials and supplies decreased by $0.3 million to $3.7 million compared to $4 million in the same comparative period of 2018, and as a percentage of revenue decreased by 0.4% to 3%.Corporate costs in the second quarter of 2019 decreased by $0.1 million to $2.9 million compared to $3 million in the same comparative period of 2018, and as a percentage of revenue decreased by 0.5% to 4.5%. On a year-to-date basis, corporate costs remained constant at $5.5 million compared to the same comparative period of 2018, and as a percentage of revenue decreased by 0.2% to 4.5%. The decrease as a percentage of revenue is primarily related to the timing of initiatives to support the corporation's growth and business strategies across the plant. Now looking at our capital resources. Distributable cash flow for the second quarter of 2019 was $8.2 million, and our payout ratio was 38.9%, and on a year-to-date basis was $13.8 million and 46%, respectively. In addition, the company paid out $0.3 shares -- per share in dividends during the quarter for total consideration of $3.2 million.Looking to our capital resources for the 6 months ended June 30, 2019, distributable cash flow was $13.8 million, and our payout ratio was 46%. Year-to-date, the company has paid out $0.6 per share in dividends for total consideration of $6.3 million. Debt to total capitalization for the 6 months ended June 30, 2019, was 28.7%, an increase from 26.4% at December 31, 2018, reflecting the impact of the increase in capital expenditures related to the new Vancouver facility.Net working capital at June 30, 2019, was $36.2 million compared to its working capital position of $34.8 million at December 31, 2018. The increase in working capital is primarily attributable to the adoption of IFRS 16, timing differences related to the cash settlement of new plant equipment, the timing of income tax recovery, deposits related to equipment and the timing of cash receipts from customers. At June 30, 2019, total assets increased to $361 million compared to $322.2 million at December 31, 2019 (sic) [ December 31, 2018 ], and total liabilities increased to $168.5 million from $123.6 million. Shareholders' equity decreased slightly at June 30, 2019, from December 31, 2018, to $192.5 million from $198.7 million.I'll now turn things back over to Linda for her concluding remarks.

[Linda Jane McCurdy, President, CEO & Director]

Thank you, Kristie. While capital costs over the past few years have been significant, what we have as a result is a highly efficient network with capacity to profitably grow our business for the long term. As Kristie touched on in her remarks, now that we've completed this last major investment cycle that saw us commit $200 million towards strategic new builds, acquisitions and upgrades across our network, we expect a gradual return to historical margin levels throughout the remainder of 2019. While the completion of the transition into the Vancouver facilities marked the end of that cycle, costs associated with the transition continued into 2019. However, we've made substantial progress despite ongoing cost increases in certain areas.We continue to expect capital expenditures for the year to be much less than what we've spent over the past few years and target CapEx of approximately $5 million for 2019. As we free up cash flow through a significantly reduced capital spending program, we've increased our ability to self-fund our growth and continue to evaluate various growth opportunities. Our presence in the U.K. and Fishers has provided a good footprint to continue to grow in that geographic area.While new markets in Canada and the U.K. remain a target, we also look to existing markets for consolidation opportunities similar to Linitek. Consistent with this strategy and as noted in our press release and MD&A, in July we entered into a share purchase agreement in the U.K. to purchase the assets of a small competitor and intend to tuck this acquisition into our existing U.K. infrastructure. The acquisition is expected to close on September 13, 2019, for a total consideration of GBP 775,000 or CAD 1.3 million. These assets include customer contracts that represent annual revenue in the amount of GBP 1 million or CAD 1.6 million, respectively.This acquisition is a great example of our strategy to grow market share in key regions and to focus on growth opportunities that leverage our existing network of laundry facilities and that are immediately accretive to earnings. I believe the acquisition adds significant and immediate value to shareholders by strengthening our competitive position and growing market share in a new region where we currently provide limited service.We continue to evaluate other tuck-in acquisitions in both the U.K. and Canada as we execute on our strategy to grow market share. While our acquisition strategy remains a priority, using free cash to pay down debt to fund our growth also remains key. As always, we remain committed to managing our balance sheet and maintaining a strong cash position to allow us to move quickly on opportunities. At this time, I'd like to open it up to all of you to answer any questions you have with regards to the quarter.

[Operator]

[Operator Instructions] Our first question comes from the line of Maggie MacDougall.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

On your tuck-in acquisition in Scotland, could you just give a bit of information around how you will integrate that? I'm assuming it will be similar to how you've done in Canada in the past. But just seeing how it is sort of the first addition to those assets, give us a bit of an overview of the strategy.

[Linda Jane McCurdy, President, CEO & Director]

Sure. I would say that it's very similar to the Linitek acquisition in Calgary, other than it will happen more immediately. It's an operation in Aberdeen whereby we will move those accounts. We've also -- with the acquisition, there is some related equipment that we've acquired, and we will move that into our operations in Cupar. And we would expect it to be done within the month of September.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. And is it needle-moving in terms of capacity utilization of the facilities that you have in Scotland?

[Linda Jane McCurdy, President, CEO & Director]

Not overly. Again, it is on the smaller side of acquisitions, so we have sufficient capacity. And it's not going to put us at maximum capacity or will it require significant additional CapEx to be spent to integrate that volume.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. The other question I had was just more generally speaking, if you could just discuss the Canadian Vancouver facilities and where you feel you're at with regards to realizing your operating efficiencies. Based on the margin you reported in Q2, it appears as though you're quite well on your way there. But just would like some color as to how we should expect that to progress through the back half of '19 based on your most recent experience there.

[Linda Jane McCurdy, President, CEO & Director]

Sure. So I think everyone will have noticed that we have not recorded any onetime costs in the quarter, which we're very happy about. From our perspective, we've returned to a normal level of operating efficiencies, so we are not characterizing any costs as onetime. But that doesn't mean that we are at our peak operational performance yet. I think we've been -- we've signaled that Q3 and Q4 are still very important quarters for us to optimize operations, get to peak performance, and we feel good about that. But we're very pleased that we have eliminated what we would have characterized as onetime costs.

[Maggie Anne MacDougall, Director of of Institutional Equity Research]

Okay. And then looking forward, 6 to 9 months, the conclusion of that investment cycle that you've done in the last few years in optimizing the efficiency in the new facilities, does that then provide you with internal resources that were otherwise occupied that can perhaps focus on volume growth or improved efficiency in other facilities? Just wondering how that sort of changes your operating capacity in terms of management going forward.

[Linda Jane McCurdy, President, CEO & Director]

I think you've absolutely hit the nail on the head, which is we will focus on all of the things you mentioned, which is additional operating efficiencies in our U.K. operation, new business, growth through acquisition in a variety of new and existing markets. But certainly, the bandwidth of management expands now that we are done building and upgrading a number of plants over the last 5-year period.

[Operator]

Your next question comes from the line of Elizabeth Johnston.

[Elizabeth Johnston, Analyst]

Just in terms of the acquisition, just a follow-up question to that, the one in Scotland which you already talked about. In terms of those customers that you're going to be taking on, do you think there's an opportunity to grow volumes with those existing customers? Or is it more so expansion volumes in that market? What do you see as the greatest opportunity there?

[Linda Jane McCurdy, President, CEO & Director]

I would -- Elizabeth, I think it would be the latter. There will be some opportunity to perhaps increase in terms of chef wear and things like that. But it really is acquiring an existing customer base, putting more runs into that market and growing new customers as opposed to organic growth of existing customers.

[Elizabeth Johnston, Analyst]

Okay. And just in terms of that market specifically, you mentioned that you're going to be transferring some of the limited equipment into your plant in Cupar. So would -- when it comes to what mix of acquisition of these tuck-ins is attractive, do you expect that the idea will be to acquire a similar kind of company and merge it with your existing operations to leverage the fixed costs? Is that basically the strategy we should be like expecting?

[Linda Jane McCurdy, President, CEO & Director]

In this particular case, that is definitely the strategy. That is not going to be the strategy in every case. In other cases in both Canada and the U.K., there will be opportunities to acquire an existing operation. And whether management stays, i.e., the sellers stay or not, will depend on each particular opportunity. But not every acquisition will be tuck-in.

[Elizabeth Johnston, Analyst]

Okay. Great. And just a follow-up on the U.K. You mentioned in your prepared remarks, Kristie, about margin in the U.K. being impacted by commodity costs and made reference to timing of that. Just trying to get a sense of looking at the second half of 2019 in the U.K., specifically on EBITDA margin, if we should expect a similar kind of headwind.

[Kristie L. Plaquin, Chief Financial Officer]

Yes. I would suggest for the remainder of the year, it would be fairly similar in terms of the impact quarter-over-quarter.

[Operator]

[Operator Instructions] Our next question comes from the line of Justin Keywood.

[Justin Keywood, Director of Equity Research]

Just in Alberta, is there any update on additional outsourcing opportunities with the change in government?

[Linda Jane McCurdy, President, CEO & Director]

Nothing particularly newsworthy. I still think it's early days, and I don't really have anything new to add. But I will say that what is in the public domain is that there is a large focus on health care and cost reduction. So I will continue to believe that, that works well for and bodes well for ourselves, but there's nothing really new to report, Justin.

[Justin Keywood, Director of Equity Research]

Okay. And then just more broadly, there's some upcoming contract renewals going into 2020. I'm wondering, is there a potential to have more favorable pricing on these contracts? Or is the focus more just to secure the renewal and obtain the benefits just with the more efficient plants now in place?

[Linda Jane McCurdy, President, CEO & Director]

I think how I would respond to that is it depends on how we assess the market and what the competitive landscape looks like ultimately.

[Justin Keywood, Director of Equity Research]

Okay. And any indication on how these upcoming contract renewals are going? Or is it still early?

[Linda Jane McCurdy, President, CEO & Director]

It's really too early to -- until an RFP is put out, there's nothing really to comment on. And generally, they -- an RFP won't be put out until very close to the expiration of the existing contract.

[Justin Keywood, Director of Equity Research]

Understood. And one more, if I may. Just on the comments of margins progressing gradually for the remainder of 2019, would there not be -- would this not be heavily weighted in Q3, just given the seasonal strength?

[Linda Jane McCurdy, President, CEO & Director]

For sure, that is our strongest quarter. A number of factors play into that. Access to labor, by and large, will be the biggest determinant of that. But yes, you're absolutely right. It is -- it has been and will continue to be our seasonally strongest quarter for sure.

[Operator]

Our next question comes from the line of Endri Leno.

[Endri Leno, Associate]

Just a little bit if you can talk, I mean especially in the context of Q3 being your strongest quarter. But how do you see the labor initiatives that you've been instituting for some quarters now -- how do you see them playing out in Q3 that is the strongest? And have you seen any improvements in the tight markets in Québec, in B.C.? And how do you expect them to evolve over the course of the year?

[Linda Jane McCurdy, President, CEO & Director]

Yes. I would say that we continue to see tight labor markets in Québec. That has definitely not gone away. I would say in B.C., Victoria has remained fairly tight. And just through our improvements in our Vancouver plants, we've felt some relief in our 2 plants there because we've become more efficient, therefore reducing our need for labor to some extent. Doesn't mean it's not a tight labor market, but improvements and efficiency helps to reduce the number of hours required to process the volumes.

[Endri Leno, Associate]

Great. And one more for me actually. I mean you mentioned that you're bidding on several contracts. Is any of these of scale, I mean sufficiently large for our mentioning? Or are they generally kind of smaller to midsize?

[Linda Jane McCurdy, President, CEO & Director]

Smaller to midsize. I mean we've obviously seen nice revenue growth on the hospitality side of the business. We feel very good about that. On the health care side, opportunities continue to remain in the pipeline. But I would definitely say they're on the smaller to midsize. Nothing that we've seen in terms of the scale 2 years ago.

[Endri Leno, Associate]

Okay. And one last for me, if I may. I mean we have discussed this in the past, but there's new talks of Brexit becoming more of a probability rather than a possibility. So I was wondering if there is anything new you can update on that, I mean whether you feel you're fully mitigated and ready to face it should it occur.

[Linda Jane McCurdy, President, CEO & Director]

We feel we are as prepared as best we can be. You will have seen an investment in working capital. A certain portion of that is in advanced purchases of linen. That's one of the steps that we've taken to mitigate any supply chain disruption. But outside of that, we don't expect any immediate issues as it relates to labor or employee base or citizens. So it's not like they will be going anywhere as the result of Brexit. Longer term, that will be potentially an issue many service-related companies will face, but I don't think there will be anything immediate there. And outside of that, how will it impact occupancies in the hospitality segment? There's just really mixed reviews. From a business perspective, there is a potential that there will be less hotel rooms sold. That's not really our market, i.e., being in Scotland and the northeast of England, we are much more tourist-based, and with pressure on the pound, that could actually be positive for us. But outside of that, there's nothing of any consequence that we're anticipating.

[Operator]

Our next question comes from the line of Lennox Gibbs.

[Lennox Gibbs, Research Analyst]

With respect to Fishers, I recall the early intention was to upgrade the Perth and Prestonhall facilities as well as to exchange best practices. What's the status of those initiatives?

[Linda Jane McCurdy, President, CEO & Director]

So there's certainly equipment that we're looking at, and we've put several pieces in, in this year in a number of the locations. That will continue. It won't be anything monumental like a major upgrade we've seen to our second Vancouver plant. Those will continue. Those certain pieces, whether it be a single ironer, whether it be a sort platform -- or a new sort system or a tunnel will continue over the next number of years.I would say that in terms of operational improvements, work in progress. It kind of goes back to one of the questions that was raised with regards to bandwidth and time to focus on other initiatives. This is very high on our priority list. So I would say for the back half of this year and into 2020, those will be priorities for us, Lennox. And there -- and we are confident that there are opportunities there.

[Operator]

The next question comes from the line of Elizabeth Johnston.

[Elizabeth Johnston, Analyst]

Just in terms of CapEx, I see in the quarter there was about negative $5 million in the purchase of PP&E. I'm assuming some of that is related to payments on existing contracts. So for the second half, if we were to assume another $2.5 million, would that be in the right range?

[Kristie L. Plaquin, Chief Financial Officer]

You're certainly correct in terms of a portion year-to-date relates to existing contracts. In terms of -- that would be a reasonable assumption, another $2.5 million.

[Operator]

There are no further questions at this time.

[Linda Jane McCurdy, President, CEO & Director]

Thank you, everyone, for joining today. And as always, Kristie and I are completely available for any additional questions if anything should arise. Thank you, everyone, and we look forward to being back to you in Q3.

[Operator]

This concludes today's conference call. You may now disconnect.