K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2022-Q3

[Operator]

Good day, and welcome to the K-Bro Linen Inc. Third Quarter 2022 Results Call. Today's conference is being recorded.

At this time, I would like to hand the 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 third 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 facts are considered to be forward-looking. Certain material factors or assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in 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, and good morning, everyone, and thank you for joining us today to review our 2022 3rd quarter results.

I'll focus on our main highlights of the third quarter, and Kristie will provide more details on our financial performance and our balance sheet. I'll then come back to you and update you on our outlook for the remainder of the year. In terms of the highlights, I'm pleased with our 2022 third quarter results with revenue and EBITDA of $73.6 million and $11 million for the quarter, with overall 19.7% 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. and the full impact of our new AHS province-wide contract. We've been successful in implementing price increases to offset the higher input costs, the full benefit of which will be seen in 2023.

The ongoing COVID-19 pandemic and certain geopolitical events have resulted in rising and unstable commodity costs and inefficient labor markets. On the commodity front, we've put in place our U.K. natural gas hedge through 2024.

And on the labor front, we focused on retention of existing staff in addition to implementing strategies to recruit and hire new staff. We've achieved success in labor in certain markets, but we're still focusing our efforts in other markets. In light of current labor markets, we anticipate returning to 2019 margins in the second half of 2023.

In 2022, approximately 62.9% of K-Bro's consolidated revenue was generated from healthcare institutions, returning towards our prepandemic revenue mix.

Hospitality revenues were at 94% of prepandemic levels on a consolidated basis. For the 3 months ended September 30, 2022, the corporation saw a 9% increase in consolidated health care revenue, while consolidated hospitality revenue significantly increased by 39% as a result of a pickup in tourism and business travel as COVID-19 restrictions were loosened.

We remain well positioned from a balance sheet and liquidity perspective with $59.1 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 $45.2 million to $39.1 million, and our funded debt to EBITDA at the end of Q3 remained conservative at just under 1.5x.

I'll now turn the call over to Kristie to discuss our detailed financial results for the third quarter, after which I'll return to talk about our outlook for the remainder of 2022 and answer any questions you might have. Kristie, over to you.

[Kristie Plaquin, executive]

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

For the Canadian division, the EBITDA margin in the third quarter decreased to 16.4% in 2022 from 20.6% in 2021. The decrease in margin is primarily related to temporary labor inefficiencies resulting from unusually competitive labor markets in certain cities in which we operate and the AHS transition, along with higher natural gas, electricity and delivery costs related to increased energy rates and the AHS transition.

For the U.K. division, in the third quarter, the EBITDA margin decreased to 10.7% in 2022 from 13.6% in 2021. The decrease in margin is primarily related to significant increases in natural gas costs.

Net earnings increased by $0.3 million from $2.1 million in 2021 to $2.5 million in 2022 and net earnings as a percentage of revenue decreased by 0.2 percentage points to 3.3% in 2022 from 3.5% in 2021.

Wages and benefits in the third quarter of 2022 increased by $5.8 million to $29.8 million compared to $24 million in the comparative period of 2021, and as a percentage of revenue, increased by 1.4 percentage points to 40.5%. On a year-to-date basis, wages and benefits increased by $22.6 million to $82.9 million compared to $60.3 million in the comparative period of '21, and as a percentage of revenue, increased by 3 percentage points to 40.3%.

The increase as a percentage of revenue is primarily related to escalating minimum wage rates, inefficiencies associated with the lack of labor workforce availability, the transitioning of the new AHS period and for the year-to-date period, a $0.9 million decrease in government assistance received in the Canadian division.

Linen in the third quarter increased by $0.7 million to $8.1 million compared to $7.4 million in the comparative period of '21, and as a percentage of revenue, decreased by 1.1 percentage points to 11%. On a year-to-date basis, linen increased by $2.9 million to $23.1 million compared to $20.2 million in the comparative period of '21. And as a percentage of revenue, decreased by 1.3 percentage points to 11.2%. The decrease as a percentage of revenue is primarily related to changes to the mix of health care linen related to the pandemic and the higher hospitality volumes processed in the current year.

Utilities in the third quarter of '22 increased by $2.4 million to $6.1 million compared to $3.7 million in the comparative period of '21, and as a percentage of revenue, increased by 2.2 percentage points to 8.2%. On a year-to-date basis, utilities increased by $8.3 million to $17.7 million compared to $9.4 million in the comparative period of '21, and as a percentage of revenue, increased by 2.7 percentage points to 8.6%. 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 third quarter increased by $3 million to $9.8 million compared to $6.8 million in the comparative period of '21, and as a percentage of revenue, increased by 2.2 percentage points to 13.3%. On a year-to-date basis, delivery increased by $10.9 million compared to $27.6 million in 2022. And as a percentage of revenue, increased by 3.1 percentage points to 13.4%.

The increase as a percentage of revenue is primarily related to rising diesel prices and the costs associated with new rural AHS business, along with delivery route inefficiencies associated with the incremental hospitality volume persist in the year and quarter.

Occupancy costs in the third quarter of '22 increased by $0.3 million to $1.2 million compared to $0.9 million in the comparative period of '21, and as a percentage of revenue increased by 0.1 percentage points to 1.6%. On a year-to-date basis, occupancy costs increased by $0.6 million to $3.4 million compared to $2.8 million in the comparative period of '21, and as a percentage of revenue, decreased by 0.1 percentage points to 1.6%.

Materials and supplies in the third quarter decreased by $0.1 million to $2.4 million compared to $2.5 million in the comparative period of '21, and as a percentage of revenue, decreased by 0.9 percentage points to 3.2%. On a year-to-date basis, materials and supplies increased by $1.8 million to $8 million compared to $6.2 million in the comparative period of '21, and as a percentage of revenue remained constant. The decrease during the quarter is due to timing of purchases for packaging costs.

Repairs and maintenance in the third quarter of '22 increased by $0.6 million to $2.6 million compared to $2 million in the comparative period of '21, and as a percentage of revenue, increased by 0.3 percentage points to 3.5%. On a year-to-date basis, repairs and maintenance increased by $1.9 million to $7.3 million compared to $5.4 million in the comparative period of '21, and as a percentage of revenue, increased by 0.2 percentage points to 3.5%.

Corporate costs in the third quarter increased by $0.2 million to $2.7 million compared to $2.5 million in the comparative period of '21, and as a percentage of revenue, decreased by 0.3 percentage points to 3.7%. On a year-to-date basis, corporate costs increased by $1.4 million to $8.2 million compared to $6.8 million in the comparative period of '21, and as a percentage of revenue, decreased by 0.2 percentage points to 4%.

Now looking at our capital resources. Distributable cash flow for the third quarter of 2022 was $7.5 million, and our payout ratio was 42.9%. In addition, 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 $30.8 million at September 30, 2022, compared to its working capital position of $30.3 million at December 31, 2021.

At September 30, 2022, total assets decreased to $321.5 million compared to $332.5 million at December 31, and total liabilities remained fairly consistent.

Shareholders' equity decreased at September 30, 2022, from December 31, '21 to $175 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.

As of the end of Q3, we have an undrawn balance of close to $59.1 million, which reinforces our strong liquidity.

Debt to total capitalization for the period ended September 30, 2022, was 18.4%. Total debt decreased in the quarter from $45.2 million to $39.1 million and was primarily due to changes in working capital. As Linda said earlier, our debt-to-EBITDA ratio was about 1.5x.

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

[Linda McCurdy, executive]

Thank you, Kristie. So with the continued rebound in the hospitality business, our overall revenue in the quarter was down only 6% from 2019. We have reopened our Perth facility in Scotland, which was temporarily closed in response to the pandemic and are now operating all of our facilities. While there are start-up costs associated with opening at Perth given the strong volumes we've seen in Scotland, we're pleased to have the additional processing capacity.

We've moved quickly to adjust to significantly increasing volumes by increasing operating hours, recalling and recruiting additional staff and ensuring all aspects of our supply chain can support the increases. Our highly experienced team has been crucial in managing the situation, and we will continue to leverage our experience for the challenges ahead. These actions have resulted in performance that we're quite pleased with given the tight labor markets and supply chain disruptions. We're pleased to say that these challenges have not resulted in any disruptions to our customers.

In terms of our 2022 outlook, we continue to see strong results in our Healthcare segment and expect that to continue as the result of the new AHS volumes that have 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.

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. We're continuing to face temporary labor inefficiencies due to the lack of workforce availability.

We are 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 we're still focusing efforts on other markets. We anticipate that labor markets will stabilize in the coming quarters.

We're still confident in our ability to return to historical 2019 margin levels once we gain efficiencies from the AHS transition. However, this will be dependent on our ability to attract and retain staff in each of these markets in which we operate.

We continue to pursue price increases to reflect the inflationary cost environment, and we anticipate returning to 2019 margins in the second half of 2023. With continued momentum in the business, we will look to refocus our -- on evaluating acquisitions in both the U.K. and North American markets as we execute on our strategy to grow our market share. As Kristie discussed, we remain well positioned from a balance sheet and liquidity perspective.

I'll summarize the main points of the quarter as continued growth and solid financial performance in an adverse environment where temporary labor inefficiencies and inflationary pressures persist. We're very pleased with our strong revenue, EBITDA.

I'll now turn it over to answer any questions you have with regards to the third quarter of 2022.

[Operator]

[Operator Instructions] We'll go ahead and take our first question from Michael Glen with Raymond James.

[Michael Glen, analyst]

Linda and Kristie, can you just -- for the Canadian market in terms of labor, I know that a lot of your health care contracts are tied to CPI adjusters, but are you having any success? Or do you have any ability to pass some of the incremental labor through in Canada over and above the CPI adjusters that you have?

[Linda McCurdy, executive]

So I would say that we are working very closely with all of our customers, both on the health care and hospitality front. And while it's taken some time, I would say that we have definitely been successful in working with our customers to pass price increases on beyond what we would normally be contractually entitled to. We have to work very hard on a customer-by-customer basis.

And again, it's happening over time. But I think they're all understanding of the environment in which we operate the economic realities. And yes, we absolutely have been successful, Michael.

All that to say that we will see the full impact of that in 2023. We have seen some amount of those increases in Q3. We will see some of it in Q4, but much of it will be reflected in 2023.

[Michael Glen, analyst]

And then I've asked you this question before, but at what level for the stock, do you think it's appropriate to -- for the company to implement the share repurchase program?

[Linda McCurdy, executive]

So I guess how I'd respond to that is that we routinely evaluate return of capital options among our alternatives. And certainly, as the pandemic continues to stabilize, we'll continue to assess how dividend increases and share buybacks will contribute to overall total returns, Michael.

[Operator]

And we'll go ahead and move on to our next question from Endri Leno with National Bank.

[Endri Leno, analyst]

The first one I want to ask is on the hospitality segment, it was down 6% versus 2019, whereas when we look at occupancy for Q3 for hotel occupancies are generally in line in 2019? I mean, is it any particular reason why K-Bro was 6% below and like how do we bridge that?

[Linda McCurdy, executive]

Sorry, I didn't -- you kind of cut out, Endri, I'm sorry, when you say -- when you looked at statistics for the hospitality industry, I didn't quite catch that, I'm sorry.

[Endri Leno, analyst]

Yes, I know, it's okay. Hotel occupancies in Q3, they were generally in line with 2019, very much so in Canada and closer in Scotland. But revenues for the hospitality were down 6%. I mean, is there any particular reason? Is it just a question of what markets you're in? Or is there any reason why you were not, let's say, in line with 2019.

[Linda McCurdy, executive]

I see what you're saying. Yes, yes okay. I understand the question. I don't have a clear answer to that. When we look at our hotel by hotel numbers, I would say that it's pretty consistent across the board in terms of what we've seen, it's not one particular market per se. Although having said that, I would say that Vancouver -- the Vancouver market lags a little bit more relative to other markets. I don't have a clear answer on that. We're not seeing anything exceptional, Endri, to be honest.

[Endri Leno, analyst]

Okay. Okay. Now fair enough, just wanted to make sure. Okay. And you made a reference -- my other question for Q4, you made a reference that you expect it to be better than 2021. I mean how is it shaping up against your expectations? Because you mentioned before that this is more corporate-driven rather than leisure. It's just kind of any additional color you can give in there where we are at this point in Q4?

[Linda McCurdy, executive]

Yes. I'd say that we continue to be -- to expect increases in both health care and hospitality. We feel positive in continued top line growth relative to 2021, likely similar to what we've seen in the quarter.

[Endri Leno, analyst]

Okay. That's good to hear. And the last one for me. You mentioned having some success in certain labor markets. Are you able to share which labor markets you are having more success than where does it needless say, to be still stabilized from a labor perspective?

[Linda McCurdy, executive]

What I would say is Quebec continues to be very challenging, both -- Montreal and Quebec City, more Montreal than Quebec City. Victoria continues to be challenging. Alberta and Saskatchewan continue to -- we see some stabilization there and also, I would say, in the U.K., Endri. We've seen more, yes.

[Operator]

[Operator Instructions] And we'll take our next question from Derek Lessard with TD Securities.

[Derek Lessard, analyst]

I think it's pretty strong results considering the environment. I just -- there was one, it looks like there was a bit of a hiccup in hospitality in September. It was down 13% versus 2019 after closing the gap quite meaningfully over the last several months. Just curious what was going on there.

[Linda McCurdy, executive]

I think there was a lot of pent-up demand over the summer, which fell off in September, and September historically has always been a very strong month for business travel, which I don't believe has come back in full force yet would be my assessment of it.

[Derek Lessard, analyst]

Okay. And then just maybe a follow-up on that. That was my second question. I guess, has your -- do you have a view on whether the business travel comes back fully?

[Linda McCurdy, executive]

Yes. I would still say we're still definitely seeing some weakness there. The leisure travel has come back in full force, but we're still seeing a lag in business travel. We are hearing from our hotels that conference demand for 2023 is increasing, but just the regular business travel still continues to lag to some extent, Derek.

[Derek Lessard, analyst]

Okay. That's helpful. And one final one for me is, there was a little change in the outlook. You're now giving the timing for the -- for your margin recovery being in the second half of 2023. Just curious if there's anything that's giving you the confidence that you can get back in the second half?

[Linda McCurdy, executive]

Yes, for sure. Again, much of it's being driven by -- all of it being driven by temporary labor inefficiencies and diesel costs in the delivery line. I would say that we have definitely seen some successes over the summer in stabilizing the labor markets. And we will continue to focus on strategies in 2023, including retention strategies as well as recruiting temporary foreign workers, which we feel good about for the back half of 2023, but it will continues to take time to recruit and work through the process to bring in temporary foreign workers.

[Operator]

We'll move on to our next question from Justin Keywood with Stifel GMP.

[Justin Keywood, analyst]

Just -- just on -- I'm just wondering because there's substantial higher scale in the quarter. And obviously, there are some headwinds to deal with labor and other challenges. But I'm just wondering, was there anything unique that would be preventing the operating leverage showing through for the business? Because I assume just with higher scale, obviously, your corporate overhead is a lower percentage. So when would we start to see that operating leverage benefit?

[Linda McCurdy, executive]

I mean really, it's going to come down to again, stabilizing the labor markets. And for many reasons, we feel good about that, i.e., talked about recruitment and retention strategies, temporary foreign workers, and continued increase -- continued price increases that we've negotiated as well as increased volumes. So we feel, again, very confident that in the back half of 2023, that we'll see those margins increase and be restored to 2019 levels.

[Justin Keywood, analyst]

Okay. And then my other question is just if there's been any change as far as the competitive landscape? Obviously, it must be much more of a challenging period for some of the smaller competitors out there? And is that resulting in perhaps new opportunities for K-Bro, either organically or through M&A?

[Linda McCurdy, executive]

Yes. So as I've continued to say acquisitions have always been a very meaning part of our growth strategy, and we expect that to continue in both North America and in the U.K., we continue to have a number of opportunities in the pipeline from tuck-ins to larger opportunities, but we don't always control the timing of these. But certainly, as we've come out of the pandemic and our competitors have returned to business as usual, these opportunities continue to be more on the forefront, and we continue to engage with our competitors to look at those opportunities, I would say.

[Operator]

We'll take our next question from Michael Glen with Raymond James.

[Michael Glen, analyst]

Just a follow-up on hospitality in Q4. Typically, there is some seasonality to take into consideration there, but there's also a lot of -- there's this pent-up demand dynamically. How much seasonality do you think there's going to be in hospitality in Q4 this year?

[Linda McCurdy, executive]

I think it will be consistent with what we normally see in Q4, but we may see -- we've seen the recovery, but we will not see as great a recovery just because we continue to see a weakness in business travel, Mike. It has not come back to the levels that we've seen leisure travel come back.

[Michael Glen, analyst]

Okay. And then just want to dial in on those transition costs with AHS. You haven't been quantifying those, but did the level of transition costs for AHS, did it diminish in Q3? Or was it roughly the same as front half of the year? And is there a -- how do we think about those sort of coming off over the next, call it, 2 or 3 quarters?

[Linda McCurdy, executive]

Yes. So it has come down, it has not come down as quickly as we had hoped. Part of that is receiving additional parts to deliver the linen in, which because of supply chain challenges will resolve itself in the first half of next year. So yes, it's come down, but not as quickly as we had liked -- we had hoped because of just challenges in supply chain, which is why we feel good about guiding that the second half of 2023 will -- margins will be restored to historical 2019 levels.

[Operator]

And it appears we have no further questions at this time. I would like to hand the call back over to Linda for any additional or closing remarks.

[Linda McCurdy, executive]

So thank you, everyone, for joining. Kristie and I are available if there's any follow-up questions, and have a great day, everyone.

[Operator]

With that, that does conclude today's call. Thank you for your participation. You may now disconnect.