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K-Bro Linen Inc
Earnings Call Analysis
Summary
Q3-2023
K-Bro Linen Systems demonstrated remarkable performance in Q3 2023, recording an 18% surge in revenue to $87 million compared to the same quarter last year. Driven by heightened hospitality activity, after lifting COVID-19 restrictions, and significant price increases, hospitality revenue skyrocketed by 30.1%, while health care revenue grew by 9.2%. The company's EBITDA followed suit, reaching $17.7 million—a 60.5% jump from Q3 2022. The firm remains strong financially, with $68 million of borrowing capacity available. An acquisition set to enhance Montreal market presence reconciles with a strategy to divest the Granby facility, expecting $0.5 million in transition costs. Distributable cash flow stood at $11.2 million, and shareholders enjoyed dividends of $0.3 per share totaling $3.2 million.
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Good morning, ladies and gentlemen, and welcome to the K-Bro Linen Systems Third Quarter 2023 Results Conference Call.
[Operator Instructions]
This call is being recorded on November 10, 2023. I would now like to turn the conference over to Kristie Plaquin. Please go ahead.
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 any 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?
Thank you, Kristie. Good morning, everyone, and thank you for joining us today to review our 2023 third quarter results.
I'll focus on the main highlights for the third quarter, and Kristie will provide more details on our financial performance and balance sheet. I will then come back to you and update you on our outlook.
So in the third quarter, we are pleased to have reported record revenues of $87 million and EBITDA of $17.7 million. Throughout the pandemic, we've worked hard to meet the changing needs of our customers while managing the impact of inflation, volatile energy prices and local labor market shortages.
Our third quarter results highlight the resilience of our business model and the responsiveness of our team. The improvement in EBITDA and margins was in line with our expectations and reflects our disciplined approach to managing operations, combined with price increases that we secured to offset inflation-related cost pressures.
Consistent with the first half of the year, 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 to 18% compared to Q3 2022 with health care revenue having increased by 9.2% and hospitality revenue by 30.1%.
With the return in hospitality revenue, health care revenues represented approximately 54% of consolidated revenue in the second quarter compared to approximately 58% in 2022. On November 1, we announced the acquisition of Villeray, our second tuck-in in the year. Villeray enhances K-Bro's position within the attractive Montreal market and as part of the transaction, K-Bro will close its Granby facility and consolidate existing volumes into Villeray's larger and more modern plant.
The new plant is strategically located close to customers and we are investing to expand capacity, consolidate volumes, enhance operating efficiency, reduce fixed costs and support significant growth opportunities.
As part of the transition, we'll incur certain onetime costs over the next 2 quarters, which are anticipated to be approximately $0.5 million for severance, decommissioning and other transition-related items. Our transition plans also include the sale of our existing Granby facility, which we anticipate to bring to market early in 2024.
We remain well positioned from a balance sheet and liquidity perspective with $68 million of additional borrowing capacity on our revolving line of credit and with an additional $25 million accordion for growth purposes.
As we emerge from the pandemic, we're excited about our future. We continue to have an active M&A pipeline and remain well positioned from a balance sheet and liquidity perspective to fund acquisitions, organic growth and our normal course issuer bid.
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. Kristie, over to you.
Thank you, Linda. The information that we are discussing today is also highlighted in our 2023 third quarter earnings press release, which we issued yesterday and detailed supplemental financial information can also be found on our Investor Relations website under the heading Financial Documents.
As a result of increased activity in the hospitality segment, price increases, the acquisition of Paranet and the elimination of COVID-19 pandemic restrictions, consolidated hospitality revenue for the 3 months ended September 30, 2023, increased by 30.1% over the comparable 2022 period, and the corporation saw a 9.2% increase in consolidated health care revenue for an overall increase in consolidated revenues of 18%. Consolidated EBITDA increased in the quarter to $17.7 million from $11 million in 2022, which is an increase of 60.5%. The consolidated EBITDA margin increased to 20.4% in 2023 compared to 15% in 2022.
For the Canadian division, the EBITDA margin in the third quarter increased to 20.4% in 2023 from 16.4% 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 third quarter, the EBITDA margin increased to 20.3% from 10.7% in 2022. The increase in EBITDA margin is primarily related to the impact of price increases, increased productivity and delivery cost efficiencies.
Net earnings in the third quarter of '23 increased by $4.2 million to $6.7 million compared to $2.5 million in the comparative period of 2022 and as a percentage of revenue, increased by 4.3% to 7.7%. The increase in net earnings is primarily related to the flow-through in EBITDA items.
Wages and benefits in the third quarter of '23 increased by $3.1 million to $32.9 million compared to $29.8 million in the comparative period of 2022 and as a percentage of revenue, decreased by 2.6 percentage points to 37.9%. The decrease as a percentage of revenue is primarily related to the impact of price increases and labor efficiencies achieved.
Linen in the third quarter of '23 increased by $0.7 million to $8.8 million compared to $8.1 million in the comparative period of 2022 and as a percentage of revenue, decreased by 0.9 percentage points to 10.1%. The decrease as a percentage of revenue is primarily related to the change to the mix of Linen and higher hospitality volumes processed compared to the prior year.
Utilities in the third quarter of '23 increased by $0.5 million to $6.6 million compared to $6.1 million in the comparative period of 2022, and as a percentage of revenue decreased by 0.6 percentage points to 7.6%. The decrease as a percentage of revenue is primarily related to the impact of price increases, coupled with lower gas costs in the Canadian marketplace.
Delivery in the third quarter of '23 increased by $0.2 million to $10 million compared to $9.8 million in the comparative period of 2022, and as a percentage of revenue decreased by 1.8 percentage points to 11.5%.
The decrease as a percentage of revenue is primarily related to the optimization of high-frequency routes, resulting in delivery cost efficiencies, combined with lower fuel rates.
Occupancy costs in the third quarter of '23 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 1.6%.
Materials and supplies in the third quarter of '23 increased by $0.6 million to $3 million compared to $2.4 million in the comparative period of 2022, and as a percentage of revenue, increased by 0.3 percentage points to 3.5%.
Repairs and maintenance in the third quarter of '23 increased by $0.6 million to $3.2 million compared to $2.6 million in the comparative period of 2022, and as a percentage of revenue, increased by 0.2 percentage points to 3.7%. The increase as a percentage of revenue is primarily related to timing and price increases.
Corporate costs in the third quarter of '23 increased by $0.6 million to $3.3 million compared to $2.7 million in the comparative period of 2022, and as a percentage of revenue remained constant at 3.7%.
Now looking at our capital resources. Distributable cash flow for the third quarter of '23 was $11.2 million. 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 $39.6 million at September 30, '23 compared to its working capital position of $36.6 million at December 31, 2022.
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 $125 million and a further $25 million accordion for growth purposes. At the end of Q3, we had an undrawn balance of close to $68 million on our operating line and the additional $25 million accordion for growth purposes, reinforcing our strong liquidity.
Debt to total capitalization for the period ended September 30, 2023, was 24.2%. The debt decreased in the quarter from $63.6 million to $55.2 million and was primarily due to the change in working capital items. Our debt-to-EBITDA ratio, excluding leases, was just under 1.5x.
I'll now turn things back over to Linda for additional commentary. Linda?
Thank you, Kristie. Q3 marks an important milestone for K-Bro as we put the headwinds of the pandemic behind us. Throughout the pandemic, we worked hard to meet customers' evolving needs as dependable partners. At the same time, we encountered volatile energy prices, local labor market shortages and cost inflation.
We've been successful in securing price increases to offset inflation-related costs. And going forward, we expect EBITDA margins to follow historical seasonal trends.
We continue to see momentum in both health care and hospitality segments. Our health care segment remains steady, and our hospitality segment continues to see good levels of activity with a return of business and international travel.
Strategic acquisitions of high-quality operators with leading market positions in key regions continue to be an important contributor to K-Bro's overall growth profile. We're pleased with our acquisitions of Villeray and Paranet and believe they will further enhance K-Bro's growth profile.
The events of the past 3 years has been a catalyst for certain strategic opportunities that were previously not actionable. 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 our positions.
We're proud of our history of responsible growth, and we're committed to a sustainable future by putting people first, being dependable partners and embracing environmental stewardship. We're finalizing our inaugural sustainability report, which will be published by year-end.
On May 15, we announced a normal course issuer bid to purchase up to 881,000 common shares during the 12-month period commencing May 18, '23 and ending May 17, 2024. During the third quarter, approximately 50,000 shares were repurchased and on a year-to-date basis, we've repurchased just over 100,000 shares for approximately $3.3 million.
In summary, we're pleased to put the headwinds of the pandemic behind us. We're excited about our outlook, and we continue to see momentum in both segments of our business. Going forward, we expect EBITDA margins to follow historical seasonally adjusted trends. I'll now turn it over to answer any questions you have with regards to the third quarter.
[Operator Instructions]
Your first question comes from Derek Lessard from TD Cowen.
This is Cheryl calling in for Derek. Congrats on the strong quarter. So our first question is on the outlook. So in the press release, you noted that you expect margins to follow historical seasonal trends going forward. Just wondering if you could clarify that for us. Is it fair to interpret it as you see yourself going back to the 2019 margin level starting Q4?
There's still some recovery to happen in Q4. But yes, that's basically in line with what we're saying, Cheryl.
And my second question is on hospitality segment. Obviously, very strong performance year-to-date. I'm curious how much more momentum do you see in both leisure and business travel given the macro backdrop. And a follow-up to that is, as we look at business travel specifically, industry data since it suggest that it's still down versus 2019. Just wondering like if you feel there's more recovery in business travel and if you expect that to get falling back to pre-pandemic?
So I would say that it is difficult for us to know what is a business and what is a leisure traveler from our discussions with our hospitality partners, I think that's what you said is consistent. Business travel is still down. And their commentary is that it will continue to take extended periods of time for it to fully recover if it does fully recover.
In terms of our outlook of the strength of hospitality and the outlook for it, again, as we talk to our partners, our hospitality partners, they do expect a strong 2024.
Your next question comes from Kyle McPhee from Cormark Securities.
First question, regarding the facility consolidation, moving your Montreal site into the Villeray facility, do you expect that to trigger any disruption for your adjusted EBITDA margin in the first half of next year when you're doing the consolidation beyond the $0.5 million of costs -- onetime costs that I assume won't hit adjusted EBITDA margins? And then looking out to the back half of next year, should we expect to see noticeable synergies that maybe you can help quantify for us?
Yes. So the transition of our existing customer base is happening between now and the end of the year. And we don't expect a lot of dislocation as the result of that transition outside of what we guided for onetime costs of approximately $0.5 million, which will happen over the balance of this year and into Q1.
And in terms of your second question, I was just thinking, Kyle, what that was, and it's do we expect synergies in the back half of the year? Yes, we are also, as announced in our press release, upgrading the Villeray facility with some additional capital, which will go into the first half of the year and we would expect operating efficiencies to result in the back half of the year in the Villeray facility. And we have not disclosed the synergies, but we definitely will see synergies and operating efficiencies as the result of both the consolidation and the efficiency-enhancing equipment that we've added and are moving forward with.
Got it. Is it fair to say with all these synergies in hand kind of back half of next year that you should be starting to push over the 2019-type margin profile?
I would say that we would expect some improvements but haven't disclosed anything outside of the fact that we expect to get back to 2019 margins, but there is upward opportunities with the synergies and consolidation and efficiency-enhancing equipment for sure.
And then do you have more site consolidation plans, specifically in the Quebec City area? I think you now have 2 sites out there after the Paranet deal.
We do not have any plans at the moment to consolidate those 2 operations and it remains to be a conversation and a discussion we have. But at this point, we expect to maintain 2 facilities and are assessing the market and the growth potential in that market.
And then last one. Your CapEx jumped in Q3, specifically the project CapEx. Can you provide some color on what that was for?
Sure. Kristie, I'll take that over to you.
Yes, absolutely. Mainly just the ongoing maintenance and strategic CapEx that we had previously disclosed. The -- there was some increase just in the first part of the year for ongoing carts that were still required for the AHS transition, but really the bump in Q4 is consistent with our initial disclosure of $8 million annually.
Your next question comes from Michael Glen from Raymond James.
Okay. Just to go back on to the CapEx because the number that you gave in the MD&A is $8 million for the year. So is -- like what would be the expectation for Q4 then for CapEx? Because I guess if you're spending on Villeray, are you spending on Villeray then in Q4 or that all falls into the first half of next year?
It will -- we'll likely make some deposits in Q4 for the Villeray CapEx. Having said that, the equipment won't arrive until 2024, so the flow-through on the current CapEx until 2024.
Okay. And for CapEx in '24, it would be like the $5 million for Villeray and then your regular ongoing maintenance, so that would -- which I think you usually talk about, is that $8 million -- or is that $5 million or $8 million for that number? So I'm just trying to get a sense of what CapEx in '24 might look like.
Yes. Absolutely. So you're right, there'll be the $5 million for Villeray. And then in addition to that, we anticipate spending $8 million in CapEx to support operations similar to what we've disclosed in 2023 as well as an additional onetime $4 million investment in the U.K. and this onetime investment in our Perth location will be made to improve margins and supports significant ROI and capacity growth.
Okay. And for the Paranet and the Villeray acquisitions, can you -- if I'm thinking about both of those on a combined basis, are you able to give like a rough idea of the split between health care and hospitality revenue from both of those or either one, however, you can get it?
Yes.
Go ahead, Kristie.
Yes. So on the Villeray transaction, it'd be about 40% health care, 60% hospitality. So just under -- or just over 1/3, 2/3. And on the Paranet, it would be fairly similar, about half and half.
Okay. And for organic, I'm just like -- for the organic growth that you're seeing in Canada so far this year on health care, I'm just trying to back into what the number might look like. It does look like it's been -- it was up on an organic basis in Q3. I'm just wondering, is that the case? And I'm just wondering what's underlying that, if it is the case?
I'd say, half of that is made up from price increase and half of it is increased activity during the fall period. A small amount of it would be new business.
Okay. And then new business wins next year, is there a good pipeline there?
We're feeling good about growth opportunities on the health care segment in a number of our markets, yes.
[Operator Instructions]
Your next question comes from Justin Keywood from Stifel Canada.
On the proposed dismantling of AHS, is that expected to have an impact for the Alberta business?
We do not expect anything to change from a supply chain and procurement perspective. As we understand it, it is more clinically based and delivery of clinical services. So we would expect it to be business as usual for us.
So no change to the recently expanded contract, I guess, it was about 1.5 years ago?
Certainly, no changes to that. I mean, if there were any changes, that would really be reporting structure and organizational structure and how procurement fits into the overall restructuring. But certainly nothing as it relates to our contract.
Okay. Understood. And then just with the 2 acquisitions in the Quebec or Montreal region, just trying to understand if there's a broader strategy here, any particular attributes that are compelling for the area and if there is opportunity for additional M&A?
I would say, we're very pleased with these 2 acquisitions, very solid operators, good infrastructure, great reputations in the market. And so we look and have been very pleased with the earlier one in the year and are very excited about the Montreal acquisition and able to shore up our position in both of those key markets.
In terms of additional acquisitions, as I guided, we feel very good about the pipeline. And after a 3-year hiatus, we feel that things are moving in the right direction and are quite excited about it.
And is the pipeline pretty broadly based as far as geographies?
Key focus is Canada and the U.K. But as I've said over the last decade, we continue to look at other geographies as well. But for us, the key focus at the moment is Canada and the U.K.
Okay. And then a question for Kristie, I think I heard 1.5x leverage, if you can verify that? And then also the pro forma net debt to EBITDA and capacity post the recent transactions?
Yes. It was just under 1.5x, Justin. And I guess in terms of capacity post Villeray, we had about $68 million undrawn on the line of credit before the acquisition of Villeray, so roughly $58 million left and the acquisition of Villeray would bring the funded debt-to-EBITDA level to around 1.5x.
What's the comfort level?
I think 2 to 3x. Sorry, go ahead, Linda.
Yes. No. That was what I was going to say as well.
We have a follow-up question from Derek Lessard from TD Cowen.
I just wanted to circle back on labor. You noted some markets are stabilizing. And just wondering if you could highlight any sequential improvement from last quarter. And any markets that you're particularly seeing the improvements and those that you feel are still under pressure?
I think one of the reasons that Q3 was strong is the improvement in the labor line combined with the optimization that we've seen as the result of streamlining the Alberta AHS expanded contract. And I would say, in many of our markets, labor has been much more accessible, and we chalk that up to inflationary pressures that have resulted in more activity and more people looking for work and getting out and having to work to fight off higher inflation -- the cost of higher inflation.
There are some tighter markets I would say that certainly, Alberta and in particular, Edmonton, has faced some tightness with rising energy costs. But overall, we have seen an improvement across the board in Canada and in the U.K.
And then last one for me is on pricing. Just given where your costs are trending, do you expect any additional pricing actions from here?
Most of the hard work that we went through last year in terms of working with our customers to secure out-of-contract price increases have flowed through. And so from a go-forward standpoint, I would say they would be more normal contractual increases that take into account increases in labor and increases in general inflation. So most of -- all of our -- the high percentage of our onetime increases are reflected in the results.
We also have a follow-up question from Michael Glen from Raymond James.
So coming off of the Q3 in the hotel business, Q4 is always seasonally slower in that segment.
But for example, I'm just going to ask you to get a little bit specific with the guidance for Q4, like the $18.4 million in Canada in hotel, like what's realistic to think about for Q4? Just thinking about everything that's going on.
We still are seeing strong activity and so I would say we expect to be double-digit over last year.
And that would be pretty much the same between both Canada and the U.K., I guess?
Yes.
And we have another follow-up question from Kyle McPhee from Cormark Securities.
So you guys have some pretty expensive U.K. natural gas hedges rolling off exiting next year. Based on where gas prices are now, I think that means a good amount of margin expansion for you heading into 2025 just from that one moving part. Do you guys consider locking in the lower gas prices over a longer period of time at this point, given all the turmoil on that side of the world?
To your point, our hedge in the U.K. comes off at the end of '24. And we are definitely looking at extending our hedges since there has been some reduction in cost in that geography, yes, it's something that we are looking to move forward with.
There are no further questions at this time. I'll turn it back to Linda for closing remarks.
Well, thank you, everyone, for joining today. And if there's any follow-up, please reach out to Kristie or myself. And I hope everyone has a great day. Thank you so much.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.