K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the K-Bro Linen Second Quarter 2022 Results Conference Call. [Operator Instructions] This call is being recorded on August 9, 2022.

I would now like to turn the conference call over to Kristie Plaquin. Please go ahead.

[Kristie Plaquin, executive]

Thank you, operator, and good morning, everyone. Thank you for joining us today and welcome to our second quarter 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 statements made during our prepared remarks or in the Q&A portion of our 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 could affect the results are detailed in the corporation's public filings.

I'll now turn things over to Linda McCurdy, who will provide her insights and remarks on the quarter. Linda?

[Linda McCurdy, executive]

Thank you, Kristie, and good morning to everyone, and thank you for joining us today to review our 2022 second quarter results.

As Kristie said, I'll focus on the main highlights of our second quarter, and Kristie -- I'll turn it back to Kristie, who will provide more details on our financial performance and our balance sheet. I'll come back to you and update you on our outlook for the remainder of the year.

So in terms of overall highlights, I'm pleased with our 2022 second quarter results with revenue and EBITDA of $70.9 million and $9.7 million for the quarter, with an overall 34.6% increase in revenue over the same period last year. Going forward, we expect to continue to benefit from the strong recovery in hospitality volumes in both Canada and the U.K., the full impact of our new AHS province-wide contract as transition costs will taper off. We have a new natural gas hedge put in place in April of this year through the end of 2024, which will also help going forward. And we expect improvements in our labor recruitment and retention and certain supplementary price increases in both Canada and in the U.K. will also help going forward.

While we continue to face cost pressures, we believe that these positive trends will provide a larger impact on our results going forward. In 2022, approximately 65% of K-Bro's consolidated revenue was generated from health care institutions, which is lower compared to 85.5% in 2021.

As a result of the COVID restrictions being eased for the 3 months ended June 30, 2022, the corporation saw a 1.9% increase in consolidated health care revenue, while consolidated hospitality revenues significantly increased by roughly 175%, as the result of a pickup in tourism and business travel. Hospitality revenues were at 94% of pre-pandemic levels on a consolidated basis.

We remain well-positioned from a balance sheet and liquidity perspective with $52.5 million of additional borrowing capacity on our revolving line of credit and with an additional $25 million accordion for growth purchases. Total debt increased in the quarter from $36.6 million to $45.2 million and our funded debt to EBITDA at the end of Q2 remains conservative at just over 1.5x.

I'll now turn the call over to Kristie to discuss our detailed financial results for the quarter, after which I'll return to talk about our outlook for the remainder of the year. Kristie, over to you.

[Kristie Plaquin, executive]

Thank you, Linda. The information we are discussing today is also highlighted in our 2022 second quarter earnings press release we issued yesterday and detailed supplemental financial information can be found on our Investor Relations website under the heading Financial Documents.

Consolidated EBITDA in the second quarter of 2022 decreased by $2.5 million to $9.7 million compared to $12.2 million in the comparative period of 2021. For the Canadian division, the EBITDA margin in the second quarter decreased to 15.1% in 2022 from 25.9% in 2021. The decrease in margin is primarily related to government assistance received in the Canadian division of $0.5 million in 2021 compared to nothing in 2022. Additional labor costs incurred due to temporarily tight labor markets in certain cities in which we operate, the repricing of the corporation's existing business in Edmonton and Calgary AHS, which took effect on August 1, 2021, and higher delivery costs related to increased fuel rates and the AHS transition. For the U.K. division, in the second quarter, the EBITDA margin remained relatively flat compared to 2021.

Net earnings decreased by $1.8 million from $3.4 million in 2021 to $1.6 million in 2022 and net earnings as a percentage of revenue decreased by 4.2 percentage points to 2.3% in 2022. The change in net earnings is primarily driven from the reduction in EBITDA as well as higher finance costs related to the revolving credit facility.

Wages and benefits in the second quarter of 2022 increased by $9.7 million to $28.5 million compared to $18.8 million in 2021 and as a percentage of revenue, increased by 4.4 percentage points to 40.1%. The increase as a percentage of revenue is primarily related to escalating minimum wage rates, inefficiencies associated with the lack of labor workforce availability and the transitioning of the new AHS business, as well as a $0.5 million decrease in government assistance received in the Canadian division in 2021.

Linen in the second quarter of 2022 increased by $0.9 million to $7.6 million compared to $6.7 million in the comparative period of 2021 and as a percentage of revenue, decreased by 2 percentage points to 10.7%. The decrease as a percentage of revenue is primarily related to the change in the mix of health care and hospitality linen related to the COVID-19 pandemic.

Utilities in the second quarter of 2022 increased by $3.1 million to $6 million compared to $2.9 million in the comparative period of 2021 and as a percentage of revenue, increased by 2.9 percentage points to 8.5%. The increase as a percentage of revenue is primarily related to the higher cost of natural gas, particularly in the U.K.

Delivery in the second quarter of 2022 increased by $4.2 million to $9.5 million compared to $5.3 million in the comparative period of 2021 and as a percentage of revenue, increased by 3.4 percentage points to 13.4%. The increase as a percentage of revenue is primarily related to rising fuel costs and the costs associated with the new rural AHS business.

Occupancy costs in the second quarter of 2022 increased by $0.2 million to $1.2 million compared to $1 million in the comparative period of 2021 and as a percentage of revenue, decreased by 0.2 percentage points to 1.7%.

Materials and supplies in the second quarter of 2022 increased by $1 million to $2.9 million compared to $1.9 million in the comparative period of 2021 and as a percentage of revenue increased by 0.5 percentage points to 4.1%. This is due to cost increases, higher packaging costs related to the new AHS business, and higher chemical costs due to changes in the mix of volume resulting from the COVID pandemic.

Repairs and maintenance in the second quarter of 2022 increased by $0.8 million to $2.5 million compared to $1.7 million in the comparative period of 2021 and as a percentage of revenue, increased by 0.3 percentage points to 3.5%. Corporate costs in the second quarter of 2022 increased by $0.9 million to $3 million compared to $2.1 million in the comparative period of 2021 and as a percentage of revenue increased by 0.1 percentage points to 4.2%, remaining fairly constant.

Now, looking at our capital resources. Distributable cash flow for the second quarter of 2022 was $5.4 million, and our payout ratio was 59.3%. 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 $35.2 million at June 30, 2022, compared to its working capital position of $30.3 million at December 31, 2021.

The change in cash from operations is primarily due to the change in working capital items, which was driven mainly by the impact of higher hospitality volumes and the timing of trade payables and collection of cash receipts from customers, as well as the procurement of linen and payment of income taxes payable.

At June 30, 2022, total assets decreased to $329.7 million compared to $332.5 million at December 31, 2021, and total liabilities increased to $152.3 million from $146.1 million. Shareholders' equity decreased at June 30, 2022, from December 31, 2021, to $177.4 million from $186.4 million.

As far as our debt is concerned, we continue to 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 Q2 2022, we had an undrawn balance of close to $52.5 million, which again reinforces our strong liquidity. Debt to total capitalization at June 30, 2022, was 20.7%. Total debt increased in the quarter from $36.6 million to $45.2 million and was primarily due to changes in working capital items we discussed earlier. As Linda said earlier, our debt-to-EBITDA ratio was just over 1.5x.

I'll now turn things back over to Linda for any additional commentary. Linda, go ahead.

[Linda McCurdy, executive]

Thank you, Kristie. So as we discussed with the rebound in the hospitality business, our overall revenue in the quarter was down only 6% from 2019. We again had to move quickly to adjust to significantly increasing volumes by increasing operating hours, recalling and recruiting additional staff and ensuring all aspects of our supply chain could support the increases.

We're pleased to report that we also successfully reopened our first plant in the quarter. While there were start-up costs associated with opening up the plant, given the strong volumes we've seen in Scotland, we're pleased to have the additional processing capacity. As a result, all of our processing facilities are now in full operations. Our highly experienced team has been crucial in managing the situation, and we'll continue to leverage our experience for the challenging environment. These actions have resulted in performance that we're quite pleased with, given the tight labor markets and supply chain disruptions. We're very pleased to say that these challenges have not resulted in any disruption to our customers.

In terms of our 2022 outlook, we continue to see strong results in our Health care segment and expect that to continue as a result of the new AHS volume that has now been fully transitioned as of April. Permanent conversions to reusable products as well as efforts by hospitals to reduce the backlog of procedures that have been delayed during the pandemic will also support strong health care volumes.

From a hospitality perspective, we believe it's reasonable to expect continued improvements in client activity when compared to 2021 due to a gradual return to business and international travel as COVID restrictions implemented in both Canada and the U.K. have been substantially reduced.

From an input cost perspective, we continue to face natural gas cost structure, particularly in the U.K. in April 2022 to mitigate this instability, we locked-in into natural gas supply rates in the U.K. until December of 2024. Based on these locked-in rates, we anticipate natural gas as a percentage of revenue to be at about 2 percentage points from historical levels. We do expect to mitigate these cost increases with price increases to our customers, although there will be some lag in implementing these price increases.

We're also continuing to face labor pressure -- labor cost pressure due to the lack of workforce availability. We're focused on implementing strategies to recruit and hire new staff as well as existing labor force retention and have achieved some success in certain markets, but this is an area we still continue to focus our efforts on.

We are still confident in our ability to return to historical 2019 margin levels once we've gained efficiencies from the AHS transition. However they will also be dependent upon attracting and retaining staff in each of the markets in which we operate. With the successful completion of the transition of the rural business in the beginning of April and as expected, this has resulted in onetime transition costs that we anticipate will continue into late 2022 when we fully optimize our operations. In addition we continue to pursue price increases to reflect the inflationary pressures we're experiencing in many areas.

We are excited to report that we have extended our contract with 3sHealth in Saskatchewan to provide service to the entire province for an additional 6 years to May 31, 2031. We've had a very collaborative relationship with 3sHealth since we began servicing the province in 2015, and we service more than 200 sites in both urban and rural parts of Saskatchewan. We're pleased to have earned the confidence of 3sHealth as they extended our agreement and it comes months after we were awarded an 11-year contract to service the entire province of Alberta and our continued position as the primary provider to the Lower Mainland in B.C.

We remain well positioned from a balance sheet and liquidity perspective, as Kristie discussed. In addition, a strong concentration of our Canadian revenue is from the health care sector at approximately 53% of consolidated revenue.

With continued momentum in the business and as hospitality revenues continue to recover to 2019 levels, we will continue to focus on evaluating acquisitions in both U.K. -- the U.K. and Canada as we execute on our strategy to grow our market share, and this will continue as we move forward into the remainder of 2022 and into 2023.

So let's say, the main highlights of the quarter would be solid financial performance in an adverse environment where there has been significant global supply chain disruptions, unprecedented labor shortages and inflationary pressures. We're pleased with our results, both from a revenue and EBITDA perspective.

I'll now turn it over and open up the line for any questions you may have with regards to the quarter.

[Operator]

[Operator Instructions] Your first question comes from Michael Glen from Raymond James.

[Michael Glen, analyst]

Just to start, when I look at your utilities line and I think about the hedges, I'm looking at the gross dollar figure on the utilities line and the number you reported in Q2. Does the hedge make that number better in Q3?

[Linda McCurdy, executive]

Yes, it definitely does. I mean it's not -- as a percentage of revenue, we said historically 2% to 3%, but we expect going forward, that will come down by approximately 0.5% and will come down further as we're able to implement price increases.

[Michael Glen, analyst]

Okay. And how do you gauge the way the hedge is set up? Is -- are there any concerns like we read these articles about natural gas shortages and -- in various parts of Europe. Is there any concern on your part regarding the actual supply of natural gas through the back half of the year?

[Linda McCurdy, executive]

We don't have any concerns. But again, it is an ever-evolving and changing environment. We have worked hard to ensure that we're with a credible supplier. We do know that throughout Europe, there have been a number of natural gas suppliers who have actually run into financial difficulty. We know that Germany has had to bail out their largest provider.

At this point, we don't have any concerns, and we believe we did sufficient due diligence to ensure that we're with a credible counterparty. But it is an evolving environment. But today, we feel good.

[Michael Glen, analyst]

Okay. And then just in terms of Canada, can you update in terms of the pipeline of RFP opportunities on the health care side that you see over the next 18 months? What does that look like?

[Linda McCurdy, executive]

Listen, I would say that it would be similar to historical levels anywhere from the $1 million to $5 million range with the exception of there could be some larger opportunities. Again, I've talked historically about larger centers that may be looking for alternate solutions across the country, and we continue to hear that those are conversations that are happening and whether it's a large outsourcing opportunity or in Ontario or across the country that those conversations are happening.

[Operator]

Your next question comes from Kyle McPhee from Cormark.

[Kyle McPhee, analyst]

Just a first question on the 3sHealth contract in Saskatchewan. So the commentary on your filing suggests it was renewed on similar terms resealed contract. Can you clarify what that means? Does that mean the EBITDA contribution the same and plan -- you took price gains? Or did pricing stay the same and presumably now you're making lower EBITDA margin on it.

[Linda McCurdy, executive]

So I would say that we certainly didn't take price reductions. That's for sure. There are price increase mechanisms and certain protections in certain areas, and we don't like to get into too much detail on each specific contract, but they're favorable terms as it relates to the current environment.

I would also say that Saskatchewan is a market where we're not feeling an over of the same pressures as we are in other markets. For example, on the labor front, it has been a stable market. We haven't had the turnover. We haven't had the lack of availability of labor force that we've seen in other markets. All that to say that we're comfortable with the extension and the protections we have from a price perspective going forward.

[Kyle McPhee, analyst]

Okay. That's helpful. And then on your Hospitality segment revenue, it's great to see the big rebound happening, getting close to pre-COVID levels from 2019. But I'm wondering if you expect to fully return to 2019 levels at some point. Maybe some of your clients no longer exist in that segment if they were unable to survive COVID. Can you offer color on that?

[Linda McCurdy, executive]

We haven't seen a lot of our customers not continue on. I think the real unknown for us and crystal ball for us, where we're not sure is what does Q4 look like. We do expect to see a solid Q3. But Q4 has historically been supported on the hospitality volume front by conference business travel. And so we're a little unsure as to what that's going to look like.

For the year, we expect to be at 80% to 85% of historical 2019 hospitality levels. And I think as we get into Q4, we'll have much more visibility into what 2023 looks like. I will say that for the quarter, the U.K. is actually exceeding top line revenue in the quarter. So we've seen a very, very solid rebound in that market.

[Kyle McPhee, analyst]

Got it. And is it -- after all those lasting dynamics are done, is it feasible that maybe your hospitality business as higher than pre-COVID, but like I guess I'm asking what are your views on new volume wins with new clients for that segment that could happen kind of near, medium term?

[Linda McCurdy, executive]

Yes. Those opportunities exist. I think our key focus at this point is continuing to pursue price increases. Not that we're not interested in new volume, obviously and opportunities exist. But we are working very closely and diligently to pursue price increases with existing customers.

[Operator]

Your next question comes from Endri Leno from National Bank.

[Endri Leno, analyst]

The first one I have, and if I heard correctly in your prepared remarks, Linda, you mentioned that the cost of the AHS contract might stretch it later into 2022. So number one, I just wanted to confirm that. And then tied in on the previous question that I had in that if the transition wrapped up in April, I mean, should we have seen a bit less of a cost or less of an inefficiency, let's put it that way in Q2.

[Linda McCurdy, executive]

Great questions. I would say that labor continues to be challenging in a number of our markets. Alberta is one of them, and it's further exacerbated by the transition. I would say that we are confident in our ability to get back to labor cost as a percentage of revenue closer to 2019 levels. It is taking a bit longer than we expected, but we're confident in our ability to do it.

We are in some of our markets having better traction in terms of attracting and retaining staff. It's been slow and coming, but through the efforts of our some differentiated recruiting methods and strategies, we are getting additional people through the door. It just -- quite frankly, it takes time to train them. There's still turnover that goes along with that. And so yes, I am saying that we expect those costs to continue in Q3 with Q4 seeing a much larger improvement is our expectation.

[Endri Leno, analyst]

Okay. That's good. That's good to hear. And just to confirm, was it also labor that impacted the inefficiencies in the hospitality routes that you referenced in the MD&A? Or is there something else in there?

[Linda McCurdy, executive]

Labor is a challenge on every aspect of our business. So all that to say that we're not hitting productivity targets that we know we can achieve because of a challenging labor market. So it's on both sides of the business. But I still will go back to the fact that we are seeing some improvement.

[Endri Leno, analyst]

Okay. No, that's good to hear. And one last one for me. If you're looking at the hospitality monthly performance in your MD&A, there was a bit of deterioration in June versus May when compared to 2019. Is this because June 2019 was stronger than May '19? Or was there any changes month-over-month in 2022?

[Linda McCurdy, executive]

Kristie, can you comment on that?

[Kristie Plaquin, executive]

Sorry, Endri, I just want to make sure I understand your question. You're saying May 2019 with …

[Endri Leno, analyst]

That's what I wanted to clarify. So in that monthly performance, for example, you had that May 2022 was down 3% versus May 2019, whereas at June 2022 was down 8% versus June 2019. So I just wanted to clarify that, that is because June '19 was stronger than May '19 or whether you saw…

[Kristie Plaquin, executive]

Yes. Sorry, I didn't quite -- yes, that's exactly what it would be. June client activity tends to be stronger than made just from a seasonality perspective. So that's exactly correct.

[Endri Leno, analyst]

Okay. Got you. Okay. And actually, one last one. The last one for me that I have actually. When you talk about price increases with your customers, are these conversations more kind of backward looking in the sense that you have a certain level of, for example, minimum wage increases? Or would they be forward-looking in that, let's say, a couple of other provinces might increase minimum wages and you try to incorporate those future increases in the discussions that you have. And that's it for me.

[Linda McCurdy, executive]

Yes. So I think that it's dependent on the customer. But I think what we are trying to accomplish is a way of structuring things with a number of our large clients that is prospective as well as gives us protection in various areas. So diesel, not just changes in minimum wage because we see changes in minimum wage and have been built into our contracts. But the -- what we're experiencing right now is not minimum wages and even attracting employees in many cases.

So we are working very hard to make them more flexible and to be more reflective of the actual changes in our cost structure. Without making it so complicated that it won't be attractive for our customers to consider.

[Operator]

Your next question comes from Justin Keywood from Stifel.

[Justin Keywood, analyst]

Just on the labor challenges. So obviously, this is affecting many industries. And in particular, we're hearing it starting to impact the hospitals, and we've heard of some shutdowns of emergency rooms for a period of time. I'm wondering, is this affecting the volume that K-Bro processes at all?

[Linda McCurdy, executive]

On the health care front, it can have an impact on the operating room, linen. We've seen certain areas that are a little bit softer than we would have expected. The other area that we are seeing on the health care is the PPE that we provided during the pandemic. So isolation scrub suits, we have definitely seen a reduction in those volumes. So how much of that is tied to reduced cases versus staff shortages is really difficult for us to tell to evaluate. But definitely, we are seeing some impact on existing products that are going into the hospitals over the last number of months.

[Justin Keywood, analyst]

Is there like any metrics that you look at as far as preparing for volume as far as -- like we've always heard of the backlogs for elective surgeries, like has that changed at all where it may not be showing up in results today, but there's pending -- like I assume these surgeries still need to be done. So there's pending increased volume ahead.

[Linda McCurdy, executive]

The only metric we really have, and we do work closely with our department heads, in particular, the SPD department to determine what the needs are to determine what cases will be, but it's not a perfect science. Generally, it translates to increases in daily quota. So we may have no more than a week visibility into what that looks like, Justin. And that's the level of forward-looking information that we have is basically and a weekly snapshot of it.

[Justin Keywood, analyst]

Okay. And then just on the competitive front, I assume some of the smaller companies out there are in a more challenged situation with less efficient plants. Are you seeing that translate to new opportunities at all for K-Bro, either organic wins or through possible M&A?

[Linda McCurdy, executive]

We are definitely viewed as the consolidator both in Canada and as a significant player in the U.K. We do know that there are some operators out there who are dealing with the same challenges that we are and don't have the level of automation. We also are -- acquisitions have been a very meaningful part of our growth strategy, and we expect that to continue both in Canada and the U.K. It is a focus certainly of the executive team, and we're confident that it will result in acquisitions over the next period of time. What is that period of time? I would say it's a focus of our efforts. And when there's enough balls in the air, something is bound to happen.

[Operator]

[Operator Instructions] Ms. McCurdy, there are no further questions at this time. Please proceed.

[Linda McCurdy, executive]

All right. So thank you everyone for your participation today. I wish you all a great day. And Kristie and I are available if there's any questions at a later point. Thank you very much. Bye for now.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.