K-Bro Linen Inc

TSX:KBL

Earnings Call Transcript 2021-Q4

[Operator]

Good morning, ladies and gentlemen, and welcome to the K-Bro Linen Systems Inc. Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] This call is being recorded on March 16, 2022.

I would now like to turn the conference call over to Ms. 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 fourth quarter and year-end 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 cautioned not to place undue reliance on these statements. Actual results could differ materially from those anticipated. Risk factors that could affect the results are detailed in the corporation's public filings.

I'll now turn things over to Linda, 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 2021 and fourth quarter results. I'll focus on the main highlights of 2021 and our outlook for the year. Kristie will provide more details on the financial performance and balance sheet. And of course, we'll have a Q&A at the end. In terms of the highlights, I'm pleased with our 2021 annual results with revenue and EBITDA of $224 million and $42.8 million for the year, which are up 13.9% and 12.9%, respectively, over 2020.

Our health care revenues continued to be strong throughout the year with an annual increase of 10% from 2020 and 20% from 2019. The 10% increase from 2020 is coming from higher volumes due to increased patient activity and usage practice changes due to COVID, price increases and the new rural Alberta Health Services volume, which was offset by the repricing of the corporation's existing business in Edmonton and Calgary with AHS as part of our new 11-year agreement. The transition of the new rural business from AHS commenced in late Q3 2021 and is anticipated to be completed by mid-2022. As a result of the pandemic restrictions gradually being eased, we've seen consolidated hospitality revenue increase by 26.6% for the year as the result of a pickup in tourism and business travel.

We remain well positioned from a balance sheet and liquidity perspective with $51.6 million of additional borrowing capacity on our revolving line of credit and with an additional $25 million accordion for growth purposes. Total debt decreased from the quarter from $38.3 million to $38 million and our funded debt to EBITDA at the end of Q4 remains conservative at just over 1x.

I'll turn the call over to Kristie to discuss our detailed financial results for the year, after which I'll return to talk about our outlook for 2022. Kristie, over to you.

[Kristie Plaquin, executive]

Thank you, Linda. The information we are discussing today is also highlighted in our fourth quarter and 2021 earnings press release issued yesterday and detailed supplemental financial information can also be found on our Investor Relations website under the heading of Financial Documents.

As a result of the COVID-19 pandemic restrictions being eased, consolidated hospitality revenue for the 3 months ended December 31, 2021, increased by 146.6% over the comparable 2020 period, and the corporation saw a 1% decrease in consolidated health care revenue for an overall increase in consolidated revenue of 23.5%. The slight decrease in health care revenue is a result of decreased COVID-19 activity levels and the repricing of our existing AHS business that went into effect August 1, offset by the new rural AHS volumes.

On a year-to-date basis, consolidated revenue increased by 13.9% to $224 million compared to $196.6 million in the comparative period of 2020. In 2021, approximately 74.4% of K-Bro's consolidated revenue was generated from health care institutions, which is lower compared to 76.9% in 2020, and this is primarily related to the COVID-19 pandemic restrictions being eased, which drove stronger hospitality client activity.

Consolidated EBITDA increased in the year to $42.8 million from $38.2 million in 2020, which is an increase of 11.9%. The consolidated EBITDA margin decreased to 19.1% in 2021 compared to 19.5% in 2020. The decrease in margin is primarily related to lower government assistance received in the Canadian division of $0.9 million in 2021 compared to $8.3 million in 2020, offset by the impairment of assets of $5.5 million in the first quarter of 2020, restructuring costs of $1.6 million and bad debt expense of $0.5 million in 2020 as well as additional labor costs incurred due to exceedingly tight labor markets in certain cities in which we operate, repricing of the corporation's existing business in Edmonton and Calgary with AHS in advance of the new rural business being transitioned and transition costs for the new AHS accounts.

Net earnings increased by $4.9 million or 129.8% from $3.8 million in 2020 to $8.7 million in 2021, and net earnings as a percentage of revenue increased by 2% to 3.9% in 2021 from 1.9% in 2020. The change in net earnings is primarily related to the flow-through items in EBITDA, lower finance costs related to the revolving credit facility and offset by higher income tax expense.

Wages and benefits increased by $17.2 million to $84.8 million compared to $67.6 million in the comparative period of 2020 and as a percentage of revenue increased by 3.5% to 37.9%. The increase as a percentage of revenue is primarily related to a $6.2 million decrease in government assistance received in the Canadian division, escalating minimum wage rates and inefficiencies associated with temporary tight labor markets and the transitioning of the new AHS business, offset by restructuring costs of $1.1 million in 2020 related to the COVID-19 volumes.

Linen increased by $3.1 million to $27.9 million compared to $24.8 million in the comparative period of 2020 and as a percentage of revenue remained relatively constant at 12.5%. The increase in spending is primarily related to the additional health care and hospitality volumes processed compared to the prior year. Utilities increased by $1.9 million to $13.5 million compared to $11.6 million in the comparative period of 2020 and as a percentage of revenue remained relatively consistent at 6%. The increase in spending is again primarily related to additional volumes processed compared to the prior year.

Delivery increased by $4 million to $24.7 million compared to $20.7 million in the comparative period of 2020 and as a percentage of revenue increased by 0.5% to 11%. The increase as a percentage of revenue is primarily related to $0.7 million decrease in government assistance received in the Canadian division, offset by management's efforts to offset the impact of COVID-19 in the delivery operations of each plant through temporary reductions in the delivery force, logistics and delivery optimizations.

Occupancy costs increased by $0.3 million to $3.9 million compared to $3.6 million in the comparative period of 2020 and as a percentage of revenue remained relatively constant at 1.7%. Materials and supplies increased by $2.1 million to $9.1 million compared to $7 million in the comparative period of 2020 and as a percentage of revenue increased by 0.5% to 4.1%. 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 increased by $0.7 million to $7.7 million compared to $7 million in the comparative period of 2020 and as a percentage of revenue remained constant at 3.4%. Corporate costs decreased by $1 million to $9.5 million compared to $10.5 million in the comparative period of 2020 and as a percentage of revenue decreased by 1.2% to 4.2%. The decrease as a percentage of revenue is primarily related to the decrease in spending in relation to a 2020 provision for bad debt expense of $0.5 million and a provision in 2020 for restructuring costs of $0.5 million, the timing of initiatives to support the corporation's growth and business strategies across the plants and a reduction in CEWS in the Canadian division.

Now looking at our capital resources. Distributable cash flow for the fourth quarter of 2021 was $6.6 million, and our payout ratio was 48.8%. 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 $30.3 million at December 31, 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 payables and collection of cash receipts from customers. The corporation's capital structure includes working capital, a committed revolving credit facility and share capital.

At December 31, 2021, total assets increased to $332.5 million compared to $323.8 million at December 31, 2020, and total liabilities increased to $146.1 million from $134.3 million. Shareholders' equity decreased at December 31, 2021, from 2020 to $186.4 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 Q4, we had an undrawn balance of close to $60 million, which reinforces our strong liquidity. Debt to total capitalization for the period ended December 31, 2021, was 17%. Total debt decreased in the quarter from $38.3 million to $38 million. As Linda said earlier, our debt-to-EBITDA ratio is just over 1x.

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

[Linda McCurdy, executive]

Thank you, Kristie. As we discussed, with the rebound in the hospitality business, our overall revenue in the quarter was only down 1% from 2019. As a result, we had to again quickly adjust to significantly increased volumes by increasing operating hours, recalling and recruiting additional staff and ensuring all aspects of our supply chain could support the increase.

Our highly experienced team has been crucial in managing the situation, and we'll 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 did not result in any disruption to our customers.

In terms of our 2022 outlook, we continue to see strong results from our health care segment and expect that to continue as the result of the new AHS volume that will fully be transitioned as well as the 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 an improvement in client activity when compared to 2020 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.

While client activity on the hospitality front is still below historical norms, the increases we've experienced since Q2 2020 have resulted in the reopening of all of our operations with the exception of our Perth plant in Scotland, which we anticipate will open in Q2, 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 grows. We expect our biggest short-term challenge will continue to be recruiting and attracting labor to support the growth in revenue.

On the Alberta front, again, I can't express how pleased we are to have the opportunity to expand our long-term relationship with AHS. We began processing health care volume in Alberta in the 1980s, and we've worked closely and collaboratively with AHS over the past 30 years to earn their confidence and trust. We're happy that we'll continue to provide service for all of our existing customers in Alberta, while also being awarded the rest of the province. Our focus in the fourth quarter and for the first half of '22 has been and will be to [ clean and fully ] transition [ the ] rural business. As expected, the transition has resulted in onetime costs that we expect to continue for the first half of 2022 until we've fully optimized our operations.

From an input cost perspective, since early March 2022, particularly in the U.K., the corporation has faced significant volatility in the cost of natural gas due to current geopolitical events. As a result of this instability based on current natural gas supply rates, we anticipate natural gas as a percent of revenue to increase 3 percentage points from historical levels for 2022. That's assuming an average price of approximately 12p per kilowatt hour were to remain in effect for the balance of the year. We do expect to mitigate these costs with price increases to our customers, although there may be some lag.

We remain well positioned from a balance sheet and liquidity perspective, as Kristie discussed. In addition, a strong concentration of our Canadian revenue is from the health care sector at approximately 81% of consolidated revenues. We're confident that as we work through additional costs associated with the AHS transition and as we see temporary relief in labor markets in certain cities in which we operate and offset the natural gas effects with price increases, we will see a strong 2022. With continued momentum in the business and as hospitality revenues begin to recover to 2019 levels, we will look to refocus on evaluating acquisition opportunities in both the U.K. and Canada as we execute on our strategy to grow our market share, and this will continue into 2022.

So I'd say the main highlights of the year would be solid financial performance in an adverse environment where there's been significant global supply chain disruptions and unprecedented labor shortages. We've produced strong cash flow generation and a demonstrated resilience of our business model. We're very pleased with our strong revenues and EBITDA. And finally, I'm very proud of our employees who have demonstrated continual flexibility and an unwavering commitment to providing the essential services that we provide to our customers.

I'll now turn it over to any questions we have with regards to the fourth quarter and 2021 results.

[Operator]

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

[Derek Lessard, analyst]

I'm going to start off with inflation and the impact on your margins in the quarter. Obviously, there was a big contraction there. I was just wondering if you could maybe help us dissect the bigger buckets or quantify the impacts from things like labor and the repricing of the AHS business and transition costs and maybe any other meaningful buckets that you saw there.

[Linda McCurdy, executive]

Sure. You bet, Derek. So obviously, on a quarter-over-quarter basis, we've seen a significant change in labor, which has gone up about 6 percentage points. The point I would make there is as it's compared to Q4 of 2021, there is a 6 point increase. But if we look -- and there's several things that are impacting that, all of which, when we compare to 2021 are things like CEWS, where CEWS, the government subsidy program, reduced the labor cost input. But as we look at that 6%, I'd say, in the quarter, about 1% of that is CEWS and the remaining 5%, I'd say about half of that is due to changes in the compensation structure and minimum wage and the remaining half of that's related to tight labor markets, absenteeism resulting from Omicron as well as transition costs from AHS, both of which will impact us into Q1 and Q2, we expect, certainly the AHS transition costs until we've optimized those. So labor is, for sure, one of the big buckets.

Another bucket would be delivery, which, again, as we take on the AHS volume, which are rural volumes, there's optimization that will have to continue, but will continue to impact us for Q1 and Q2. But we do expect improvement of that line over time. I'd say those are the 2 biggest buckets to comment on at this point.

[Derek Lessard, analyst]

Okay. And I guess, I mean, you did point to you're expecting some relief in the tight labor market as part of your comments on your 2022 outlook. So I guess how should we be looking at the evolution of your margins as we move through the year?

[Linda McCurdy, executive]

Sure. So again, given the transition and I'm, of course, talking all post IFRS, what I would say is the first half of the year, we'll continue to see an impact on labor and impact on delivery. And I will say, let's dissect the 2 into Canadian and -- Canadian margins and the U.K. margins. I think it's reasonable to expect in the back half of the year, we will return to 2019 post-IFRS margins in Canada.

I think the U.K., there's a lot more unknowns there, with the largest impact being natural gas and where will that settle out, which, given the whole geopolitical environment, is a little bit more difficult to foreshadow how things will play out in the U.K. But from a Canadian perspective, I'd say the back half of the year, we would expect margins to fall more closely in line with 2019 margins.

[Derek Lessard, analyst]

Okay. That's very helpful.

[Linda McCurdy, executive]

I will make one other comment. From a top line perspective, I would expect health care revenues to remain strong with inflationary increases for 2022 relative to 2021, and we are expecting a nice rebound or a continued rebound of hospitality revenues at, we anticipate, about 80% of 2019 levels, both in Canada and the U.K.

[Derek Lessard, analyst]

Okay. And then maybe actually just one follow-up on that. In terms of your price increases, can you just maybe remind us of your ability to pass on price increases and sort of the typical lag that we should expect?

[Linda McCurdy, executive]

So I would say there's annual price increases in all of our -- the majority of our contracts, which are tied to specific metrics, whether that be CPI or changes in minimum wage. And there is some element of a lag. They are generally annual increases. So as there are cost increases that may happen because of minimum wage or other factors, there can be a lag because they're only annual price -- they're annual price increases.

I would say in the U.K., our price increases are actually quite tightly tied to changes in the retail cost index, which includes changes in minimum wage, changes in textile costs and to some extent, changes in natural gas. I think where things change a little bit is when we see the unprecedented changes in natural gas that are really off the charts. And where we will and have had very open and honest dialogue with our customers about the situation and our ability to pass on those unprecedented cost increases, which we are feeling quite positive about.

[Operator]

Your next question comes from Michael Glen with Raymond James.

[Michael Glen, analyst]

Linda, just want to come back on the natural gas. So the 3% increase that you're flagging, that's for the company as a whole or is that a U.K.-specific market headwind?

[Linda McCurdy, executive]

Yes, it's for the company as a whole, Michael, but the -- by far, the largest part of that is the U.K. Canada is a very, very small part of that.

[Michael Glen, analyst]

Okay. And then last conference call, for that, when you were speaking -- I actually think it was Kristie that was speaking about the U.K. business, you had been looking at some contracts to potentially lock in some natural gas pricing. Did you -- were you not able to get -- or how do those contracts work exactly? And is it -- does it give you any benefit to have any sort of contracts in place?

[Linda McCurdy, executive]

Yes. So I mean I think from an overall hedging strategy perspective or policy perspective, in Canada, we're hedged at about 65%. In the U.K., historically, there was about -- a hedging policy at about 50%. As those hedges came off in Q3 of last year, we started to see we started to see increases in the pricing of hedging out for several years. Of course, that only exacerbated with the Ukraine situation.

So to lock in in late last year or into January or February of this year would mean locking into prices that we've never seen ever over the last 10 years. And for perspective, we used to pay GBP 0.02, 2p per kilowatt hour and spot rates are at about 11p per kilowatt hour. So to lock in to those rates given the volatility just does not seem like the right strategy.

[Michael Glen, analyst]

Okay. And are you able to -- you're flagging the transition costs. Is there any way to give us a number on what they would have been in the quarter?

[Linda McCurdy, executive]

The biggest impact would have been on labor. And so I'd say, of the 6 point difference, about 2% of that would have been AHS, 1.5% to 2% would have been AHS.

[Michael Glen, analyst]

Okay. That's 2% of the 6% in that labor cost inflation line?

[Linda McCurdy, executive]

Yes. That's right. Yes.

[Michael Glen, analyst]

Okay. And the delivery, just want to get clarification. The delivery cost inflation, is that -- that is absorbed by you? Or is that -- is there a way to just put that right through to the customer on delivery cost?

[Linda McCurdy, executive]

So part of the delivery cost is transitory or transitional as we optimize routes in Alberta. And we would be compensate -- the balance of it would be increase in fuel rates. Some of it would be CEWS. And compensation for that would come through our annual lift that would be tied to CPI or to basically other pricing formulas. There's no separate carve-out for increases in fuel costs, for example.

[Operator]

Your next question comes from Endri Leno with National Bank.

[Endri Leno, analyst]

I'm going to -- not to beat the dead horse, but back on the natural gas, the comments that you had. I just wanted to clarify, first, what portion of your utility cost is natural gas. And I don't know if you can give us an estimate on what the impact would be in terms of the overall EBITDA or EBITDA margin, should they continue at the level -- at the price that you quoted in the outlook.

[Linda McCurdy, executive]

So historically, natural gas would be about 4 percentage points of our -- 6% -- [ 4 of ] 6%, which is all of utilities. And again, if natural gas stays at the approximate 12p per kilowatt hour, that would have a 3 percentage point impact on overall margins. Again, we do feel that we will be able to pass on the largest portion of that. Over what period of time becomes a little bit of a question mark. But we do feel we'll make good progress of passing those costs on over the next several quarters.

[Endri Leno, analyst]

That's a great clarification, Linda. The other question I have is actually on M&A. You said you're open to both geographies, but I mean it was a -- you called it out in the outlook. I was wondering if you can talk a little bit more about the M&A outlook and strategy, apart from geography, but be it in size, multiples, end market. Any color there would be great.

[Linda McCurdy, executive]

Again, one of the comments I made, we're feeling quite positive about the fact that we're well on our way to transitioning the large win as it relates to AHS. And as we move further into 2022, we see targets more interested in engaging, especially because there's been a nice rebound in hospitality volumes. In terms of valuation, I would say, historically, we've seen them anywhere in the 6 to 9x range, Endri. I don't see a big shift in that at this point.

[Endri Leno, analyst]

Okay. That's good. The last question for me, it's in more -- and you called out chemicals and supplies, there is inflation pressures there as well as supply chain. I was wondering if you can comment on the dollar amount that we saw in Q4, should that continue or come down in 2022? And then the other part to that is anything about kind of linen shortages, if you're experiencing anything there. I know you keep a lot of inventory, but if you're seeing anything on the linen side.

[Linda McCurdy, executive]

We have seen some delays in linen delivery, but we are -- we buy 6 months ahead. But -- and as we've taken on large amounts of volumes, there have been delays. But again, as you mentioned, we do inventory and warehouse substantial linen in Canada. So we've had the ability to draw down on that. But certainly, lead times have increased. There is no question.

In terms of materials and supplies, I would say 2 aspects of that. There have been increases in chemical costs that are following the general increases that we're seeing in inflation. And the second piece of that would be in plastics, where we have seen increases in the cost of plastics. Some of that, a smaller portion of that is just additional expense to take on the new business. But there certainly has been inflationary pressure on chemicals and plastics supplies.

[Operator]

[Operator Instructions] Your next question comes from Anthony Linton with Laurentian Bank.

[Anthony Linton, analyst]

So I just wanted to come back, first of all, to the Alberta Health Services contract. I was wondering how that process is going. And then also just on the cost associated, you talked about 2% of labor. Is that kind of in line with where you thought those costs were going to be? And how should we expect that to kind of move through the year ahead?

[Linda McCurdy, executive]

How is the transition going? These transitions are complicated. We're dealing with hundreds of sites across rural Alberta. Fortunately, we have a significant amount of experience in doing so. So I would say that the transition is going as expected and it's going very, very well. We've got complete buy-in and support from our customers. And there have been nothing but positive comments from our customer as well as the end user.

In terms of the costs, I would say, these aren't unexpected. Hiring new employees, integrating new volumes, figuring out and optimizing delivery routes, this is all part of taking on large pieces of complicated business. So I would say from our perspective, it's going as expected.

[Anthony Linton, analyst]

Okay. That's good color. Just coming back to labor again, obviously, some challenges in the tight labor market. Were any of those costs related to temp workers or anything like that that you expect might subside kind of moving through 2022?

[Linda McCurdy, executive]

Yes. So what I would say is that in the latter half of Q4 as well as into Q1, Omicron definitely had an impact on absenteeism, staff shortages so -- which would have resulted in us using over time, temporary labor solutions. So yes, absolutely, those would have been part of the labor component and the labor cost increase.

[Anthony Linton, analyst]

Okay. And then just one more for me. You mentioned the reactivation of your facility in Perth in Q2. I was just wondering if you could give some color on maybe what your thought process with -- is for reactivating the facility. Is it the increased hospitality volumes? And then also, are there any start-up costs associated with bringing that facility back online?

[Linda McCurdy, executive]

Great question. Thought process in terms of bringing it back in line, we have obviously seen a dramatic increase in hospitality volumes in the U.K. that commenced in with a bit of a slow start in Q2 of 2021, but resulted in a very strong summer, very strong summer and as well as a strong Q3. We do anticipate that hospitality volumes in the U.K. will likely come back to about 85% of 2019 levels, which requires us to have the additional capacity to process those volumes.

In terms of start-up costs, there will be some amount of start-up costs in terms of some [ R&L ] required as well as rehiring and retraining, which will result in Q2 when the plant is opened.

[Operator]

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

[Linda McCurdy, executive]

Great. So thank you, everyone, for your attention this morning. And we look forward to the next communication being in -- with our Q1 results, but please feel free to reach out if there's any further questions. Thank you, and I wish everyone a good day.

[Operator]

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