K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2021-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the K-Bro Linen Inc. Third Quarter 2021 Earnings Conference Call. [Operator Instructions] This call is being recorded on Tuesday, November 9, 2021. I would now like to turn the conference over to Kristie Plaquin. Please go ahead.

[Kristie L. Plaquin, Chief Financial Officer]

Thank you, operator, and good morning, everyone. Thank you for joining us today, and welcome to our third quarter 2021 results conference call. On the line with me today is Linda McCurdy, President and Chief Executive Officer. Following our remarks today, we will open it up for questions. Before we begin, 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 Jane McCurdy, President, CEO & Director]

Thank you, Kristie. Good morning, everyone, and thank you for joining today to review our third quarter results of 2021. I'll focus on the third quarter highlights and our outlook for the year, and Kristie will provide more details on our financial performance and balance sheet. We'll then, of course, open it up to questions. In terms of the highlights, I'm pleased with our third quarter results, with EBITDA of $11.6 million and adjusted EBITDA, without the adoption of IFRS, of $9.3 million. Our healthcare revenues continue to be strong. For Q3 2021, we saw an increase of 0.4% over Q3 2020 and a 13% increase over Q3 2019. These increases (indiscernible) from price increases, temporary services provided in certain markets, product conversions, usage change practices and an overall increase in demand, including an increase for certain items because of COVID-19, with a small amount of this increase in revenue coming from the new Alberta Health Services rural business. As anticipated, with the reduction in COVID cases and hospitalizations, in Q3, we obtained a slower rate of increase in healthcare revenue than what we previously expected during the earlier phases of COVID. In addition to this, revenue was impacted by the repricing of the corporation's existing business in Edmonton and Calgary with AHS, which took effect on August 1, 2021, in advance of all of the new rural business being transitioned to the corporation. The transition of the new business from EHS commenced in late Q3 2021 and is anticipated to be completed by mid-2022. In terms of hospitality revenue as a result of the pandemic (technical difficulties)

[Operator]

Ladies and gentlemen, please stand by. Your conference will resume momentarily. Please go ahead.

[Linda Jane McCurdy, President, CEO & Director]

Thank you. Sorry about that. It seems that the call dropped. I think I ended or was beginning to discuss hospitality revenue. So in terms of hospitality revenue, as a result of the pandemic restrictions gradually being eased during Q3 2021, we have seen consolidated hospitality revenue increase gradually on a month-by-month basis. We experienced a sharp increase in hospitality revenue in the quarter, with an 80% increase compared to Q3 2020. When comparing to 2019, we saw a shortfall in July 2021 hospitality revenue compared to July 2019 hospitality revenue of 40%. In August, we saw this reduce to 30%, and in September to 28%. During October, we've continued to see improvements in client activity on a year-over-year basis. These large increases, combined with exceedingly tight labour markets in most of the cities in which we operate, increased labour costs and negatively impacted margins. We'll speak more about this later in our presentation. We remain well-positioned from a balance sheet and liquidity perspective, with $60 million of additional borrowing capacity on our revolving line of credit and with an additional $25 million accordion for growth purposes. Total debt decreased in the quarter from $40.7 million to $38.3 million, and our funded debt-to-EBITDA at the end of Q3 remained conservative at just over 1x. As previously disclosed during the quarter, we have successfully completed amendments to our existing revolving credit facility, which extended the agreement to July 30, 2024, from July 31, 2022. I'll now take a moment to update everyone on the situation with Alberta Health Services. In October 2020, AHS issued their Request For Proposal for linen services. The AHS RFP encompassed the lining services provided by the corporation to AHS under its AHS Calgary contract as well as the linen services provided by the corporation to AHS in Edmonton, for which volumes were under contract as part of 2 existing agreements until 2022 and 2023, respectively. The AHS RFP also included new volume for additional rural and urban locations in Alberta. On April 27, 2021, the corporation was selected to provide laundry services for Alberta Health Services for the entire province. The award is the result of a competitive RFP process and extends K-Bro's existing (technical difficulty)

[Kristie L. Plaquin, Chief Financial Officer]

Operator, I think we lost Linda again, so I'll just continue, and maybe you can try to get her on the line.On July 26, 2021, the corporation announced the signing of a new 11-year contract with renewal options for up to an additional 9 years to provide laundry and linen services for AHS province-wide. The contract is anticipated to add approximately $10 million in incremental annual revenue with margins consistent with K-Bro's historical adjusted EBITDA margins without the adoption of IFRS 16. The corporation expects to incur one-time transition costs and have temporary margin impacts as the new volume is transitioned into the corporation's 2 facilities in Edmonton and Calgary. It is anticipated that the corporation will return to normalized margins once the transition is complete in mid-2022. Capital expenditures are projected in the amount of approximately $10 million for new linen carts and additional equipment to support the additional volumes. The award renews all of K-Bro's existing volume in Edmonton and Calgary and awards all of the additional AHS healthcare volume for other sites in Alberta. The new volume will be serviced from K-Bro's existing state-of-the-art facilities in Edmonton and Calgary. And again, the transition of the new rural business from AHS, which commenced in late Q3 2021, is anticipated to be completed by mid-2022. I'll now discuss our detailed financial results for the quarter, and then return the call back to Linda to talk about the outlook for 2021. The information we are discussing today is also highlighted in our third quarter and 2021 earnings press release, which was issued yesterday, and detailed supplemental financial information can be found on our Investor Relations website under the heading Financial Documents. As a result of the COVID-19 pandemic restrictions being eased, consolidated hospitality revenue for the 3 months ended September 30, 2021 increased by 80% over the comparable period of 2020, and the corporation saw a 0.4% increase in consolidated healthcare revenue for an overall increase in consolidated revenue of 19.5%. The increase in healthcare revenue is from increases in volume that Linda referred to earlier, as well as the repricing of our existing AHS business that went into effect August 1, 2021. On a year-to-date basis, consolidated revenue increased by 10.7% to $161.8 million compared to $146.2 million in the comparative period of 2020. In 2021, approximately 77% of K-Bro's consolidated revenue was generated from healthcare institutions, which is higher compared to 74.7% in 2020. This is primarily related to the pandemic's effect on the hospitality segment during the first quarter of 2021 compared to 2020, as well as the impact of the pandemic on the corporation's healthcare revenue in Q2 2020. Consolidated EBITDA in the third quarter of '21 decreased by $1.1 million to $11.6 million compared to $12.7 million in the comparative period of 2020, and margin decreased by 5.8 percentage points to 18.9%. For the third quarter, 3.5 percentage points of the 5.8-point reduction in EBITDA margin is related to the lower amount of CEWS recorded in 2021 of [nil] compared to $2.1 million in 2020, with the remaining decrease being related to additional labour costs incurred due to exceedingly tight labour markets in almost all of the cities in which we operate, repricing of the corporation's existing business at Edmonton and Calgary with AHS, which took effect on August 1, 2021 in advance of new rural business being transitioned to the corporation, as well as transition costs for the new AHS accounts.On a year-to-date basis, consolidated EBITDA increased by $7.4 to $33.9 million compared to $26.5 million in the comparative period of 2020, and margin increased by 2.8 percentage points to 20.9%. The year-to-date increase is primarily related to higher revenues, impairment of assets of $5.5 million in the first quarter of 2020, restructuring and bad debt expense in 2020 of $1.6 million and $0.5 million, respectively, and is offset by lower government assistance received in the Canadian division from $7.7 million received in 2020 to $0.9 million received in 2021. Consolidated adjusted EBITDA increased in the year to $27 million from [$25.5 million] in 2020, which is an increase of 6.3%. The consolidated adjusted EBITDA margin decreased to 16.7% in 2021 compared to 17.4% in 2020. The U.K. division also received government assistance during 2021 in the amount of GBP1.6 million, or $2.8 million, which has been netted against the respective source of the expense. Beginning in the third quarter of 2020 and onwards, government assistance received by the U.K. division to the coronavirus job retention scheme required the company to share in the cost of the program. And as a result, the net impact to EBITDA during 2021 was a cost of GBP141,000 or $245,000, which represents the U.K. division's contribution for hours and certain benefits. Net earnings increased by $5.6 million, or 336.7% from $1.6 million in 2020 to $7.2 million in 2021. And net earnings as a percentage of revenue increased by 3.3 percentage points to 4.4% in 2021 from 1.1% in 2020. The change in net earnings is primarily related to the flow-through in EBITDA we discussed earlier, lower finance costs related to the revolving credit facility, and higher income tax expense. Wages and benefits in the third quarter of 2021 increased by $7 million to $24 million compared to $17 million in the comparative period of 2020, and as a percentage of revenue increased by 6.1 percentage points to 39.1%. For the quarter, the increase as a percentage of revenue is primarily related to a significant decrease in government assistance received in the Canadian division by $1.8 million due to ineligibility for the wage subsidy program compared to 2020, as well as additional labour costs incurred due to exceedingly tight labour markets in all cities in which we operate. On a year-to-date basis, wages and benefits increased by $9.6 to $60.3 million compared to $50.7 million in the comparative period of 2020 and, as a percentage of revenue, increased by 2.6 percentage points to 37.3%. The increase as a percentage of revenue is again primarily related to the significant increase in government assistance received in the Canadian division by $5.8 million to an amount of $0.8 million recorded in 2021, escalating minimum wage rates, and inefficiencies associated with the lack of labour workforce availability. It is offset by restructuring costs of $1.1 million incurred in the prior year related to COVID-19 volumes. Linen in the third quarter of 2021 increased by $1 million to $7.4 million compared to $6.4 million in the comparative period of 2020, and as a percentage of revenue decreased by 0.3 percentage points to 12.1%. On a year-to-date basis, linen increased by $1.9 million to $20.2 million compared to $18.3 million in the comparative period of 2020, and as a percentage of revenue remained constant at 12.5%. The increase in spending is primarily related to the additional healthcare and hospitality volumes processed compared to the prior year. Utilities in the third quarter of 2021 increased by $0.9 million to $3.7 million compared to $2.8 million in the comparative period of 2020, and as a percentage of revenue increased by 0.5 percentage point to 6%. On a year-to-date basis, utilities increased by $1 million to $9.5 million compared to $8.5 million in the comparative period of 2020, and as a percentage of revenue remained relatively constant at 5.9%. Delivery in the third quarter of 2021 increased by $1.70 to $6.8 million compared to $5.1 million in the comparative period of 2020, and as a percentage of revenue increased by 1.1 percentage point to 11.1%. The increase as a percentage of revenue for Q3 '21 is primarily related to decreased levels of government assistance received in Q3 2021 and exceedingly tight labour markets in certain of the cities in which we operate. On a year-to-date basis, delivery increased by $1 million to $16.7 million compared to $15.7 million in the comparative period of 2020, and as a percentage of revenue decreased by 0.4 percentage points to 10.3%. The decrease as a percentage of revenue is primarily related to management's efforts to offset the impact of the pandemic on the delivery operations of each plant through temporary reductions in the delivery labour force, logistics and delivery route optimization, offset by fixed costs, which remain constant regardless of the reduction in volume resulting from the pandemic and price increases from the renewal of outsourced freight contracts. Occupancy costs in the third quarter of 2021 remained constant at $0.9 million compared to the comparative period of 2020, and as a percentage of revenue decreased by 0.3 percentage points to 1.5%. On a year-to-date basis, occupancy costs increased by $0.2 million to $2.8 million compared to $2.6 million in the comparative period of 2020, and as a percentage of revenue remained relatively constant at 1.7%. This includes fixed costs that remain constant regardless of the reduction in volume resulting from the pandemic and is offset by rent concessions received in certain plants in the U.K. in the amount of $0.5 million recorded in the second quarter of 2020. Materials and supplies in the third quarter of 2021 increased $5.6 million to $2.5 million compared to $1.9 million in the comparative period of 2020, and as a percentage of revenue increased by 0.4 percentage points to 4.1%. On a year-to-date basis, materials and supplies increased by $1 million to $6.2 million compared to $5.2 million in the comparative period of 2020, and as a percentage of revenue increased by 0.3 percentage points to 3.9%. The increase as a percentage of revenue is primarily related to higher chemical costs due to changes in the mix of volume resulting from the pandemic. Repairs and maintenance in the third quarter of 2021 increased by $0.2 million to $2 million compared to $1.8 million in the comparative period of 2020, and as a percentage of revenue decreased by 0.3 percentage points to 3.2%. On a year-to-date basis, repairs and maintenance remained constant at $5.4 million compared to the comparative period of 2020, and as a percentage of revenue decreased by 0.4 percentage points to 3.3%. The decrease as a percentage of revenue is primarily related to the timing of maintenance activities. Corporate costs in the third quarter of 2021 decreased by $0.3 million to $2.5 million compared to $2.8 million in the comparative period of 2020, and as a percentage of revenue decreased by 1.4 percentage points to 4%. On a year-to-date basis, corporate costs decreased by $1 million to $6.8 million compared to $7.8 million in the comparative period of 2020, and as a percentage of revenue decreased by 1.1 percentage points to 4.2%. The decrease as a percentage of revenue is primarily related to a 2020 provision related to the pandemic, including bad debt, debt expense of $0.5 million from hotel closures, and one-time restructuring costs of $0.5 million, the timing of initiatives to support the corporation's growth and business strategies across the plants, and is offset by lower government assistance received. Now, looking at our capital resources. Distributable cash flow for the third quarter of 2021 was $7.9 million, and our payout ratio was 40.8%. In addition, the company paid out $0.300 per share in dividends during the quarter for total consideration of $3.2 million. The corporation had net working capital of $30.5 million at September 30, 2021 compared to its working capital position of $27.9 million at December 31, 2020. The increase in working capital is driven mainly from the impact of the pandemic and the timing of trade payable and collection of cash receipts from customers. The corporation's capital structure includes working capital, a committed revolving credit facility and share capital. At September 30, 2021, total assets increased to $330.5 million compared to $323.8 million at December 31, 2020, and total liabilities increased to $142.8 million from $134.3 million. Shareholders' equity decreased at September 30, 2021, since December 31, 2020 to $187.7 million from $189.5 million. As far as our debt is concerned, we have sufficient room on our credit facility with an operating line of $100 million and a further $25 million accordion for growth purposes. At the end of Q3, we had an undrawn balance of close to $60 million, which reinforces our strong liquidity. Debt to total capitalization for September 30, 2021, was 17.1%, total debt decreased in the quarter from $40.7 million to $38.3 million, and this was primarily due to the change in working capital items we discussed earlier, as well as our earnings from operations. As Linda said earlier, our debt to EBITDA ratio was just over 1x. I'll now turn things back over to Linda for any additional commentary. Linda?

[Linda Jane McCurdy, President, CEO & Director]

Thank you, Kristie. So as we discussed, healthcare revenue remained strong in the quarter; and with the rebound in the hospitality business, our overall revenue in the quarter was only down 9% from 2019. As [the] result, we had to again move quickly to adjust to significantly increasing volumes by increasing our operating hours, recalling and recruiting additional staff, and ensuring all aspects of our supply chain could support the increases. Our highly experienced team has been crucial in managing the situation and will continue to leverage our experience for the challenges ahead. These actions have resulted in performance that we are quite pleased with, given the tight labour markets and supply chain disruptions. We're pleased to say that these challenges did not result in any disruptions to our customers. In terms of our 2021 outlook, we continue to see strong results in our healthcare segment and expect that to continue as hospitals deal with the impact of the pandemic and continue to catch up with the backlog of procedures that have been delayed during the pandemic. While 2021 healthcare revenue has trended upward from 2019 historical rates by approximately 20%, as anticipated; as the year has progressed, the rate of increase in healthcare revenue has begun to trend down as cases drop and testing diminishes. Beginning in July, we began to see this trend.From a hospitality perspective, as we continue to move through 2021, we believe it's reasonable to expect an improvement in client activity for our hospitality segment when compared to 2020 activity levels due to a gradual return to business and international travel as COVID-19 restrictions implemented in both Canada and the U.K. begin to ease with the continued rollout of the vaccine, and we've experienced these increases in Q3 2021. While client activity on the hospitality front is still below historical norms, the increases we have experienced since Q2 has resulted in the reopening of all of our operations, with the exception of our first plant in Scotland, as well as increasing the days and hours of operations in all of our plants. We've recalled employees to meet these increased demands and will continue to adjust production schedules as demand warrants. We expect our biggest short-term challenge will continue to be recruiting and attracting labour to support the growth in revenue. 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 healthcare sector at approximately 81% of consolidated revenue. We continue to evaluate other acquisitions in both the U.K. and Canada as we execute on our strategy to grow our market share, and this will continue as we move forward in 2021 when current market conditions may lead to opportunistic situations for us. So I would say the main highlights of the quarter would be solid financial performance in an adverse environment where there have been significant global supply chain disruptions and unprecedented labour shortages. We have strong cash flow generation and a demonstrated resilience of our business model. So with that, we are pleased with our strong revenues and Q3 EBITDA. On the Alberta front, I can't express how pleased we are that we have the opportunity to expand our long-term relationship with AHS. We began processing healthcare volume in Alberta in the 1980s and have worked closely and collaboratively with AHS over the past 30 years to earn their respect and confident. We're happy that we continue to provide service for all of our existing customers in Alberta while also being awarded the rest of the province. Our focus for the balance of the year remains to seamlessly transition a significant amount of the rural business. And finally, I'm very proud of our employees who have demonstrated continued flexibility and an unwavering commitment to providing essential services to all of our customers. I'll now turn it over to answer any questions you may have with regards to our third quarter results.

[Operator]

[Operator Instructions] Your first question comes from Derek Lessard, TD Securities.

[Derek J. Lessard, Research Analyst]

Just wondering maybe if you could talk about some of the labour challenges you're seeing both domestically and in the U.K., and whether there's any differences that you're seeing between the 2 regions.

[Linda Jane McCurdy, President, CEO & Director]

Sure, certainly a very topical discussion. I think because volumes increased earlier on in the U.K. than they did in Canada, we felt it more acutely there. I think the other reality in the U.K., Derek, is that there is an impact of Brexit. So it's complicated further by Brexit and foreign nationals leaving to go back to their homeland. Everyone also will have seen in the news the tremendous shortage of truck drivers. We are definitely feeling that both in Canada and in the U.K., but even more acutely in the U.K. In Canada, we're experiencing shortages in all of our markets, but we're significantly impacted in our hospitality plants, where we have had to ramp up just so quickly. Our healthcare plants never really furloughed staff, so we had the stable workforce. And even though there's tightness in some of those markets, it was easier to recruit fewer people to support additional volumes or to run overtime. So our hospitality-dominated plants have really felt the challenge. I will say that they will continue to challenge us, and it is in Q4. We are seeing some glimmers, which is now that CERB has ended in certain of our markets, we have seen an increase in applications. So it is early days. And I guess what I would say is where we are optimistic as it relates to next year is it does give us time to more aggressively pursue and recruit people, put in place different structures, consider premiums for different shifts, as well as we are also looking at reactivating our temporary foreign worker program, which we used extensively and great experience with in 2008. So we feel we have the strategies, and we have the time before the next busy season to adjust appropriately, but it still does remain a pretty tight labour market.

[Derek J. Lessard, Research Analyst]

And you did answer my follow-up on the removal of CERB. I guess as you move past, let's call it, peak COVID issues, your balance sheet is in great shape. I was just wondering how you guys are now thinking about leveraging that balance sheet between growth opportunities, M&A and maybe returning capital to shareholders.

[Linda Jane McCurdy, President, CEO & Director]

I think we have been pretty vocal or clear about maintaining a clean balance sheet to pursue our growth opportunities. They range from small to medium to larger size, and we want to ensure that we have the balance sheet to support that. So that would be priority #1. To the extent some of those acquisition and growth opportunities don't materialize in a reasonable timeframe, we will look at returning capital to shareholders.

[Operator]

Your next question comes from Kyle McPhee, Cormark.

[Kyle McPhee, Analyst of Institutional Equity Research]

I just wanted to quickly recap some of the mechanisms and timing you have to pass on cost inflation as price increases to your clients. So for your 3 main cost buckets, wages, linen and delivery, can you remind us how quick or slow it is to execute that cost pass-through?

[Linda Jane McCurdy, President, CEO & Director]

Yes. So, I mean, each of our contracts are different. Some have more flexibility in terms of passing some of those costs on. About half of our contracts are tied to CPI, and half of them have different mechanisms built in, whether it's an adjustment for linen, whether it's an adjustment for labour. The reality of the situation, however, is most of those price increases are activated only on an annual basis on the anniversary date of the contract. Of course, those all happen throughout the year. They don't all happen on January 1 or April 1. It's all throughout the year that we would see those price increases. And so, to some extent, there is a bit of a lag.

[Kyle McPhee, Analyst of Institutional Equity Research]

And then just a follow-up specific on linen costs. I just wanted to confirm what should happen as your hospitality volumes recover back to a higher portion of your consolidated revenue mix. I think you own the linen for most of your healthcare business, but not the case for your hospitality. So should linen costs as a percentage of revenue be dropping as your hospitality business normalizes higher so that linen's kind of back to the cost intensity that we saw in 2019?

[Linda Jane McCurdy, President, CEO & Director]

I'd say that is a fair and accurate statement with the exception of the fact, in the U.K., we do own the linen for our hospitality customers. But because the weighting of the U.K. is still -- we should still see a return to 2019 levels of when all hospitality comes back.

[Operator]

[Operator Instructions] Our next question comes from Justin Keywood, Stifel GMP.

[Justin Keywood, Director of Equity Research]

I appreciate the comments around the tight labour market and the supply chain disruptions. I'm assuming some of your competitors are in a tougher situation, just given the market share of K-Bro. I'm wondering if there's any contracts that are coming up for renewal at competitor accounts. And realize this is a bit sensitive, but assuming that they could be experiencing challenges at a greater extent than K-Bro, does this become an opportunity for some new RFP wins? And if you could just describe, in general, how some of the new contracts on the healthcare side may play out going into next year?

[Linda Jane McCurdy, President, CEO & Director]

So I know you focused on healthcare. I'll touch on hospitality first. I will say that we're very pleased with, given the challenges both in Canada and the U.K. that we saw, our ability to provide a very solid service during a difficult time. And I would say that we fared incredibly well in the environment we were operating. That has resulted in a number of new wins in the hospitality piece in both Canada and the U.K. largely coming from smaller competitors in the U.K. who have just not had the access to the supply chain for linen. Of course, we don't see the full benefit of that because hospitality volumes are still, to a certain extent, subdued. But I will say that we are very pleased with our contract wins on the hospitality side of the business in Canada and the U.K.As it relates to healthcare, you did make a great point about our access to supply chain, and the largest piece of that is linen in Canada. And we are pleased to say that we have not seen disruptions in our ability to access linen to support our customers. And consequently, we've been able to deliver a high level of service to our existing customer base, but also on an emergency basis to a number of customers. How that plays out over the next 12 to 18 months in terms of contract wins and contract RFPS, I'd say there's likely anywhere $2 million to $5 million of RFP business coming up, and I think we have a very good shot at it. Again, our performance over COVID has been exceptional. Our access to supply chain, which for the case in healthcare is really linen, the balance is water, natural gas, electricity, there's been no disruptions there. So I think, between that and state-of-the-art plants, I think we have a very good chance of increasing business over the next 12 to 18 months with new contract wins.

[Justin Keywood, Director of Equity Research]

On the $2 million to $5 million in potential new contract wins on the healthcare side, would that consist of a number of accounts? Or is that primarily one opportunity?

[Linda Jane McCurdy, President, CEO & Director]

It would in a number of markets, Justin.

[Justin Keywood, Director of Equity Research]

And then just on the challenges, and I think we understand the opportunity to win contracts from competitors, but would this result in maybe some acquisition targets, maybe bringing these potential deals to the finish line in that they're experiencing even more hardship after already a tough year last year? And I'm talking more on the hospitality side, where some of these smaller competitors may look to sell to K-Bro, or is this still a bit of a longer scenario on acquiring competitors?

[Linda Jane McCurdy, President, CEO & Director]

I think, as we've seen hospitality revenues and volumes rebound, that enables us to have more meaningful conversations. People are more ready to engage. So I do think it accelerates what has been somewhat of potentially a slower process, I would concur with your conclusion.

[Operator]

Your next question comes from Eduardo Garcia, National Bank.

[Eduardo Garcia]

I wanted to have an idea of, or if you can provide some color on the volumes for Q4. Are you seeing any seasonality, especially in the hospitality business?

[Linda Jane McCurdy, President, CEO & Director]

So I'll give you my crystal-ball view. In Canada, for Q3, we were up about 53% versus 2020, but we were still down 50% 4Q relative to Q3 for 2019. I think, in both of those cases, I don't think there will be material swings from the experience we've seen in Q3. In the U.K., we were up about 100% versus 2020 and down 20% versus 2019 for Q3, and I would expect something similar for Q4.

[Eduardo Garcia]

And do you have any idea if they're coming from leisure or business travel? I know it's hard to quantify.

[Linda Jane McCurdy, President, CEO & Director]

It is very hard to quantify. My gut is that, and through discussions with our customers, it is more staycations and the leisure travel that is picking up than it is business travel.

[Eduardo Garcia]

And how about the healthcare in Ontario? Do you have any color on the (indiscernible) backlog? Is it being already recovery? Or [is it] already in motion to recover some of these backlogs (indiscernible) there?

[Linda Jane McCurdy, President, CEO & Director]

Yes. So I think, from a volume perspective, what we have previously guided in terms of healthcare volumes is that for Q4, as we've seen the decline in COVID cases, we've seen the rate of increase decline, as we talked about in our prepared notes, prepared remarks. I would say that we would expect the same for Q4. And last quarter, we had guided that we expect, relative to 2021, a high single-digit drop in healthcare revenues for the quarter. In terms of backlogs, it's a very interesting question. Everyone acknowledges that there's likely a 2-year backlog of elective surgeries. And I think what they're struggling with is some of the same things that the rest of the world is struggling with, which is access to labour. They're having tightening of labour markets with now they're requiring mandatory vaccinations, which has impacted their staffing, and they're also having supply chain issues. So even getting the medical supplies to supply the ORs to catch up on those elective surgeries is going to play out, over time. I don't think it's just the will to say we're going to get the backlog cleared up. There are some issues, supply chain issues that are going to be challenging for them to do that.

[Eduardo Garcia]

And for the cost pressures you experienced this quarter, are you able to quantify how much or what percentage was labour, what percentage was the Alberta transition, just to have an idea?

[Linda Jane McCurdy, President, CEO & Director]

So I think what we will say is that we do expect the labour line to be under pressure for Q4 for a number of reasons. We're still struggling with access to labour, and we are going through the AHS transition, which with any one of these transitions, it just takes time to integrate volume, to train staff, to figure out the new customers. So I would say that that's where we're going to see the largest impact for Q4. We have every confidence that it'll work its way through the system and believe that our margins will return to normal at the end of the transition in the second half of 2022, but there will be some short-term pain.

[Eduardo Garcia]

In terms of labour, between recurring topic over the last couple of years, finding talent for the company, I wonder if you have a long-term mitigation strategy for this.

[Linda Jane McCurdy, President, CEO & Director]

I mean, it's significantly exacerbated in the times of COVID and with strong hospitality volumes coming back. So I would say it's much more significant today than we've seen over the last several years. I do believe that this too will sort itself out. Again, the reduction in CERB, we've already seen a small positive impact in our applications. Our mitigation strategy over the last number of years has been to heavily invest in automation in our large healthcare plants, so that's one thing that has significantly helped our reliance on labour. And part of it's going to be to assess the situation and determine whether we'll have to increase wages, whether we'll have to take other steps in terms of continuing to adjust schedules and work patterns. So part of it is we don't want to react too quickly until we really understand how severe the shortages is going to be and for what period of time.

[Operator]

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

[Michael W. Glen, Equity Research Analyst]

For Q3, if we look at the run rate on the healthcare revenue relative to what the healthcare revenue run rate was in the front half of the year, I think the variances there is the COVID volumes. Is that the primary variance there? Or what are the other buckets to think about?

[Linda Jane McCurdy, President, CEO & Director]

So COVID variance, as well as repricing of our Edmonton and Calgary AHS business would be the 2 main drivers. And in COVID, there's increased use. There's conversions to reusable. There's temporary customers. So that's a pretty big bucket.

[Michael W. Glen, Equity Research Analyst]

And with the COVID volumes coming down, can you identify what are some of the specific items there that you see drop-off in?

[Linda Jane McCurdy, President, CEO & Director]

Predominantly isolation gowns, right? So in all of those testing centers, the clinicians would have a isolation gown, of which for most of our customers it's a reusable product. So as testing reduces, the usage of those gowns goes down.

[Michael W. Glen, Equity Research Analyst]

And then, I can't remember if you mentioned this, but can you just comment on the natural gas environment and how that is impacted?

[Linda Jane McCurdy, President, CEO & Director]

Actually, Kristie, why don't you take that one?

[Kristie L. Plaquin, Chief Financial Officer]

So I guess, in terms of natural gas, I think it's fairly well-known fact that natural gas rates have increased. Our existing contracts, a lot of them do expire at the end of 2021. So during the quarter, we embarked on a strategy to renew a portion of our annual consumption at revised rates, which were slightly higher than our previous rates. Based on the information that we have right now in the existing floating rates, we believe our exposure could be in the range of maybe 0.5 percentage point, but we're fairly confident, given where rates are right now, that that's all it would be.

[Michael W. Glen, Equity Research Analyst]

That 0.5 percentage point, that would be on 2022?

[Kristie L. Plaquin, Chief Financial Officer]

Based on 2019 margins, kind of normalized consumption.

[Operator]

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

[Linda Jane McCurdy, President, CEO & Director]

Well, thank you, everyone, for joining today and for your interest. We look forward to speaking with you all again at the end of Q4. But should any questions arise, please feel free to reach out to either Kristie or myself. Thanks so much, and have a great day.

[Operator]

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