K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the K-Bro Linen Systems Second Quarter 2023 Results Conference Call. [Operator Instructions]. This call is being recorded on August 9, 2023.

I would now like to turn the conference 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 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 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 could affect the results are detailed in the corporation's public filings.

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

[Linda McCurdy, executive]

Thank you, Kristie. Good morning, everyone, and thank you for joining us today to review our 2023 second quarter results. I'll focus on the main highlights of the quarter, and Kristie will provide more details on the financial performance and balance sheet. I'll then come back to you and update you on our outlook for the remainder of the year.

In terms of overall highlights, we reported revenue of $81 million and EBITDA of $14.5 million for the quarter. Our strong second quarter results with significant growth in EBITDA and margins were in line with our expectations. The improvement in margins reflects our disciplined approach to managing operations combined with price increases that we have secured to offset inflation-related costs. We continue to expect a return to pre-pandemic margins in the second half of the year, consistent with historical seasonal trends.

As with our first quarter results, we saw continued growth in health care revenue and significant growth in hospitality revenue as business and leisure travel volumes have returned. Overall, consolidated revenue increased 13.9% compared to Q2 2022, with health care revenue having increased by 4.4% and hospitality revenue by 29%.

With the return on hospitality revenue, health care revenues represented about 56% of consolidated revenue in the second quarter compared to approximately 61% in 2022. We continue to actively manage the impact of energy price increases and local market labor shortages. We remain well-positioned from a balance sheet and liquidity perspective with $34.5 million of additional borrowing capacity on our revolving line of credit and with an additional $25 million accordion for growth purposes.

Total debt increased in the quarter from $53.7 million to $63.6 million and our funded debt to EBITDA, excluding leases at the end of Q2 remained conservative at 1.8x. On May 15, we announced a normal course issuer bid and repurchased 52,756 shares during the second quarter. We anticipate continued organic growth in both Canada and the U.K. Our M&A pipeline remains active, and our balance sheet has the flexibility to provide for our near-term growth.

I'll now turn the call over to Kristie to discuss the detailed financial results for the year, 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 2023 second quarter earnings press release, which we issued yesterday and detailed supplemental financial information can be found on our Investor Relations website under the heading Financial Documents.

As a result of price increases that took effect in Q4 2022 and the first 2 quarters of 2023, the acquisition of Paranet and COVID-19 pandemic restrictions being eased, consolidated hospitality revenue for the 3 months ended June 30, 2023, increased by 29% over the comparable 2022 period. And the corporation saw a 4.4% increase in consolidated health care revenue for an overall increase in consolidated revenues of 13.9%.

Consolidated EBITDA increased in the quarter to $14.5 million from $9.7 million in 2022, which is an increase of 49.8%. The consolidated EBITDA margin increased to 18% in '23 compared to 13.7% in 2022. For the Canadian division, the EBITDA margin in the second quarter increased to 18.1% in 2023 from 15.1% in 2022. The increase in EBITDA margin is primarily related to the impact of price increases as well as labor and delivery cost efficiencies and reduced fuel rates.

For the U.K. division, in the second quarter, the EBITDA margin increased to 17.6% from 9.2% in 2022. The increase in EBITDA margin is primarily related to increases in client activity, price increases, labor efficiencies, the natural gas hedge which we put in place during Q2 of 2022, and delivery cost efficiencies along with reduced fuel rates.

Net earnings increased by $3.1 million from $1.6 million in 2022 to $4.7 million in 2023 and net earnings as a percentage of revenue increased by just over 150% to 5.8% in 2023 from 2.3% in 2022. The increase in net earnings is primarily related to the flow-through items in EBITDA.

Wages and benefits in the second quarter of 2023 increased by $2.5 million to $31 million compared to $28.5 million in the comparative period of 2022 and as a percentage of revenue, decreased by 1.7 percentage points to 38.4%. The decrease as a percentage of revenue is primarily related to stabilization of labor in certain markets, production efficiencies gained from the AHS transition and price increases secured across various markets.

Linen in the second quarter of '23 increased by $0.7 million to $8.3 million compared to $7.6 million in the comparative period of 2022, and as a percentage of revenue, decreased by 0.5 percentage points to 10.2%. The decrease as a percentage of revenue is primarily related to changes in the mix of linen and higher hospitality volumes processed compared to the prior year.

Utilities in the second quarter of 2023 increased by $0.3 million to $6.3 million compared to $6 million in the comparative period of 2022 and as a percentage of revenue, decreased by 0.7 percentage points to 7.8%. The decrease as a percentage of revenue is primarily related to the natural gas hedge strategy implemented in the U.K. during Q2 of 2022.

Delivery in the second quarter of '23 decreased by $0.1 million to $9.4 million compared to $9.5 million in the comparative period of 2022, and as a percentage of revenue, decreased by 1.7 percentage points to 11.7%. The decrease as a percentage of revenue is primarily related to optimization of high-frequency routes, resulting in delivery cost efficiencies as well as lower fuel rates. Occupancy costs in the second quarter of 2023 increased by $0.2 million to $1.4 million compared to $1.2 million in the comparative period of 2022 and as a percentage of revenue remained constant at 1.7%.

Materials and supplies in the second quarter of '23 increased by $0.3 million to $3.2 million compared to $2.9 million in the comparative period of 2022 and as a percentage of revenue, decreased by 0.2 percentage points to 3.9%. Repairs and maintenance in the second quarter of '23 increased by $0.6 million to $3.1 million compared to $2.5 million in the comparative period of 2022, and as a percentage of revenue, increased by 0.3 percentage points to 3.8%. The increase as a percentage of revenue is primarily related to the timing of maintenance activities, inflationary increases and one-time expenditures.

Corporate costs in the second quarter of 2023 increased by $0.7 million to $3.7 million compared to $3 million in the comparative period of 2022 and as a percentage of revenue, increased by 0.4 percentage points to 4.6%. The increase as a percentage of revenue in the second quarter relates to integration costs associated with the acquisition of Paranet and certain other one-time costs.

Now looking at our capital resources. Distributable cash flow for the second quarter of 2023 was $8.8 million, and our payout ratio was 36.7%. 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 $44.5 million at June 30, 2023, compared to its working capital position of $36.6 million at December 31, 2022. The change in cash from operations is primarily due to the change in working capital items, which is driven mainly from the timing of collections from health care customers.

With regards to credit and liquidity, we have a strong balance sheet and ample undrawn capacity on our credit facility with an operating line of $100 million and a further $25 million accordion for growth purposes. At the end of Q2, we had an undrawn balance of close to $34.5 million on our operating line, reinforcing our strong liquidity.

Debt to total capitalization for the period ended June 30, 2023, was 26.8%. Total debt increased in the quarter from $53.7 million to $63.6 million and was primarily due to the change in working capital items and the repurchase of shares under the NCIB. As Linda said earlier, our debt-to-EBITDA ratio, excluding leases, was 1.8x.

I'll now turn things back over to Linda for additional commentary. Linda?

[Linda McCurdy, executive]

Thank you, Kristie. So Q2 was another step towards our return to pre-pandemic margins, and I'm excited about our outlook. Price increases that we successfully secured over the last 3 quarters, along with our disciplined approach to managing operations, position us well into the second half of the year. Going forward, we see continued momentum in both health care and hospitality. Our health care segment remained steady, and our hospitality segment continues to see good levels of activity with the return of business and international travel.

Since the pandemic, labor availability has been constrained in some markets. We've experienced progress and anticipate improvement in our labor recruitment and retention. We're managing more challenging regional markets with complementary temporary foreign worker programs and our anticipated margin recovery remains dependent on our ability to continue to attract and retain staff in each of the markets in which we operate.

Strategic acquisitions have been an important contributor to K-Bro's overall growth profile and with continued momentum in our business, we're refocusing on M&A. We're pleased with our acquisition of Paranet in Quebec in March and integration is progressing well. We have an active M&A pipeline and remain well-positioned from a balance sheet and liquidity perspective, and we'll continue to be disciplined as we evaluate acquisitions.

We're focused on advancing our sustainability program for the long term. We've assembled an ESG working group that includes an experienced and diverse group of subject-matter experts, many of whom have been with K-Bro for decades. With this, we intend to publish our inaugural sustainability report by the end of the year and look forward to providing further updates on our progress.

In summary, we see continued momentum in both hospitality and health care. We are actively managing factors that affected our results since the pandemic and are eager to see the full benefit of price increases. In the second half of the year, we anticipate returning to historical 2019 margin levels consistent with historical seasonal trends.

I'll now turn it over to answer any questions you have with regards to the second quarter of 2023.

[Operator]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] First question comes from Derek Lessard from TD Securities.

[Yaozhi Zhang, analyst]

This is Cheryl calling in for Derek, who's in another call right now. Congrats on a strong quarter. So our first question is on margin expectations. You said that you expect the return to 2019 level to occur in the latter half of the year. Just wanted to get a sense of the timing. Are you expecting it to be more in Q3 or more towards Q4?

[Linda McCurdy, executive]

I think we'll see progress in both quarters and the narrowing gap as we get back to the 2019 levels. We've obviously made progress in Q2, expect to make further progress in Q3 as well and even more so in Q4.

[Yaozhi Zhang, analyst]

Okay. Got it. And could you talk about what you see as stabilization in the labor market? Also, what level of wage inflation are you seeing or expect to see in the market? And also which markets are still more challenged than the other?

[Linda McCurdy, executive]

Sure. I can say quite happily that we have seen certain markets, we're finding it easier to recruit and retain people, which is quite a shift from what we saw a year ago. In D.C., Alberta, Saskatchewan, we have -- we are having people actually walk through our door and apply for positions, which is we haven't seen in a number of years. Victoria, still -- I said D.C., but Victoria still tends to be a tight labor market, and we see some tightness in Ontario and Québec.

But as I mentioned in our remarks, we are accessing the temporary foreign worker program in many of our markets, and there have been a number of employees who have come in from overseas to help augment our domestic labor force in certain markets. And that's a strategy that we will continue to execute on. But we are seeing movements in the right direction.

In terms of wage inflation, I think it's fair to say that throughout the balance of the year, there will be changes in minimum wage. We don't pay minimum wage. But from time to time, we see pressure as the result of changes in minimum wage. Those changes have been factored into our outlook.

[Operator]

[Operator Instructions]. Next question comes from Endri Leno at National Bank.

[Endri Leno, analyst]

Congrats on the good quarter. The question I have, it's more a little bit on the pricing, but I was wondering Linda or Kristie, or both, if you can talk a little bit about how much more of the pricing is left to do if there's any? And margin improvements for the balance of the year, where do you expect most of these to come from, pricing, labor efficiencies, volumes, et cetera?

[Linda McCurdy, executive]

Yes. Sure. And happy to answer that question. I'd say a large portion of the price increases have been reflected maybe not at the beginning of Q2, but throughout Q2. So in terms of further improvement in margin, I'd say the key components would be comprised of some price increases, some labor improvement as well as relative to Q2, some normalization of corporate costs. There were -- I'm sure it's noted that it's higher in the quarter as the result of cost associated with growth initiatives, but we would expect improvements in each of those areas.

[Endri Leno, analyst]

Okay. Great. And the other question I have, I mean, it's just kind of looking at the 2 countries, Canada and the U.K., I would say U.K. performed better than Canada, even accounting for size differences. So I was wondering if you can talk a little bit about what drove this relative outperformance in the U.K., and then if you can compare and contrast the 2 regions?

[Linda McCurdy, executive]

To a certain extent, interestingly enough -- well, first of all, in the U.K., we hedged our natural gas, right, which locked that down and took the volatility away from what we saw a year ago. In certain cases, I think we are finding a more stabilized workforce in the U.K., where most of our plants are -- some of our plants in Canada are having more challenges in that area than others, but we're not seeing it as dramatic in the U.K. Again, as I mentioned, we're accessing the temporary foreign worker program in Canada and we have seen stabilization, but probably not as significant as in the U.K. I'd say that's the biggest factor.

[Endri Leno, analyst]

Great. And I'll ask one more and I'll jump in the queue. I have a few more. But if you can talk a little bit about the working capital outflow in the quarter? I think it was more receivables, but if you can talk a little bit about it? And when do you expect it to revert?

[Linda McCurdy, executive]

Absolutely. Kristie, I'll let you handle that.

[Kristie Plaquin, executive]

Sure. Thanks, Linda. Endri, so predominantly, the increase in AR would just be -- would be timing. There's a small investment as a result of the acquisition of Paranet when you compare to December. But for the most part, we would anticipate that the large majority of that would get picked up in Q3.

[Operator]

The next question comes from Justin Keywood at Stifel.

[Justin Keywood, analyst]

Great. Good to see the margin improvement in the quarter. And also just to help understand the comments on the improvement to margins historically in the back half of the year. Is there anything unique expected in Q2, either positive or negative? Just trying to bridge the comments of improved margins in the back half, but obviously, with good Q2.

[Linda McCurdy, executive]

Sure. I mean as we said in Q1, a number of things have to play out in order for it to happen in the back half of the year. There have to be improvements in labor price increases. And all of those just took time. Price increases were scheduled, and we're committed to, but scheduled over the period of the year. And on the labor front, we obviously needed help from just the overall general economic landscape. And I would say that we are very positively seeing those where it has been easier to attract labor. And even attracting labor, people have to be trained. They have to be integrated into the facilities, which all takes time.

So again, as we expected, it would take time for margins to come back, but we are confident and have seen the trajectory over the last 2 quarters and expect it to continue into Q3 and Q4. So really to answer that, Justin, I don't think there's anything that's unexpected or things that happened in Q1 or Q2 that make us any more or less confident in our ability in Q3 and Q4 other than this is pretty much how we expected it to play out.

[Justin Keywood, analyst]

Great. And just to maybe put some parameters around it. If we look at the historical margin and I guess this is going back to pre-pandemic, I think, for Q3, it typically exceeded 20%. Would that be a good rule of thumb to use?

[Linda McCurdy, executive]

That's fair. Yes, slightly above the 20% mark. That's correct.

[Justin Keywood, analyst]

Good. And then just on use of capital. We saw the share buyback start to be a bit active and obviously, the Paranet acquisition. Just how you see capital deployment going forward? Where do you see the best uses?

[Linda McCurdy, executive]

So given my comments on the M&A pipeline between our growth opportunities as well as continuing to be active on the NCIB. Those would be the 2 primary focuses, Justin. And we expect to be able to pursue both of those use of funds as we continue into the back half of the year.

[Justin Keywood, analyst]

And maybe a question for, Kristie. Are you able to provide an updated leverage ratio in the quarter and remind us of the comfort range?

[Kristie Plaquin, executive]

Absolutely. So it's just over 1.8x for the quarter, Justin, excluding the leases, and we have the ability to draw up to just over 3x, 3.25x.

[Justin Keywood, analyst]

And what would be the comfort range? Would it be up to that 3x?

[Kristie Plaquin, executive]

It's in the range of 2 to 3x, somewhere in there.

[Operator]

The next question is a follow-up from Endri Leno of National Bank.

[Endri Leno, analyst]

Thanks again. I didn't think I'd get my turn so quickly. But I was wondering -- I mean to the extent that you can talk about it, obviously, Linda, but in terms of transactions, the opportunities, where do you see them? Is it more of a Canada? Is it more of a U.K.? What kind of volume mix and sizes, if you can, I mean, obviously, to the extent you can disclose these things?

[Linda McCurdy, executive]

Yes, you bet. I'd say that Canada and the U.K. remains the key focuses. We've been fairly transparent in terms of our aspirations to continue to grow in the U.K. to be a national player. That hasn't changed and opportunities for further consolidation continue in the U.K., both in health care and in hospitality. And I'd say the same holds true in Canada, Endri. There are both health care and -- health care and hospitality opportunities. And I think the range, as previously referenced, ranges anywhere from $10 million up to possibly on the larger, the outer range of $100 million. So there's a number of opportunities out there. And as things have stabilized, business has stabilized, volumes have stabilized, it becomes easier to have those conversations with targets.

[Endri Leno, analyst]

My other question, it's a bit longer-term looking, so perhaps a bit harder to answer. But assuming we get back to the 2019 levels in the second half, no problem, right? Where do you see the margin situation beyond that? Is that a good level, generally speaking to being? Or is there any room for further improvements? And where could that -- those further improvements come from, potentially?

[Linda McCurdy, executive]

I mean obviously, looking into the crystal ball, it's hard to say how we could or would be impacted by a whole host of factors. But what I would say is we continue to have plants that operate on single shifts or single and -- a shift and a half, which means that there's excess capacity in most of our plants to take on additional volume. We continue to want to be market leaders and grow our market share. So those are all positive factors for further ongoing margin expansion into the future.

[Endri Leno, analyst]

Okay. Okay. Great. And the last one for me, foreign labor, you mentioned you're having some success with that. Are you able to talk a little bit about how much of that is in, how much more do you expect? And then as they kind of, again, like looking into the future, which we don't know, but I mean it's worth an ask. I mean, there are reports out there that there is a structural labor shortages in advanced economies. Like are you comfortable, for example, having forward label as a more permanent solution to your ops?

[Linda McCurdy, executive]

So to the first part of your question, Endri, I'd say that the majority of our approved labor market LMIA foreign workers. Most have come in by the end of Q2. There are some more to come, but I'd say the majority has arrived, but they arrived mostly at the end of Q2. Are we comfortable with this program as a long-term strategy? I would say, yes. I think the government has been fairly constructive, when there are labor shortages, of making the rules around the temporary foreign worker program more accessible. And when there's higher inflation, they narrow our ability to bring in temporary foreign workers.

So I'd say in the past, we have used it extensively. We obviously haven't in the last number of years because of different factors, including restrictions on people traveling and foreign workers traveling, but it has played a meaningful part over the last decade, and I would expect it would continue. By no means is it going to make up 20%, 30%, 40% of our workforce, but even being able to bring in 10% to 15% to 20% of your workforce is extremely helpful in being able to provide stability.

[Operator]

The next question is a follow-up from Derek Lessard at TD Securities.

[Yaozhi Zhang, analyst]

Yes. So another follow-up we have is you mentioned the optimization of high-frequency routes in your prepared remarks. And just curious if you could provide some -- maybe quantify that. And how much more are you expecting to see in the latter half of the year?

[Linda McCurdy, executive]

So this predominantly relates to optimization of the roots in Alberta from taking on the rural volume for AHS. Some of you may remember the supply chain constraints that we had and disruptions that we had as it relates to linen cart. So most of this impact comes from Alberta. And we think we're pretty much at the end of the road there. And I think it's a percentage point improvement on the delivery line that we've seen as the result of that.

[Yaozhi Zhang, analyst]

Okay. Linda, just to confirm that the improvement in linen cart is part of the route optimization efficiency, correct?

[Linda McCurdy, executive]

Yes, that's correct.

[Operator]

Thank you. There are no further questions at this time. You may proceed.

[Linda McCurdy, executive]

Well, thank you, everyone, for joining today. Kristie and I are available if there's any follow-up questions. And I just wish everyone else, everyone a good day. Thank you.

[Operator]

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