Good morning, ladies and gentlemen, and welcome to the K-Bro Linen Systems third quarter 2023 results conference call. At this time, all lines are in a listen-only mode. Following the presentation, we'll conduct a question and answer session. If at any time during this call you need assistance, please press star zero for the operator. 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. In the third quarter, we are pleased to have reported record revenues of CAD 87 million and EBITDA of CAD 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 healthcare revenue and significant growth in hospitality revenue as business and leisure travel volumes have returned. Overall, consolidated revenue increased 18% compared to Q3 2022, with healthcare revenue having increased by 9.2% and hospitality revenue by 30.1%. With a return in hospitality revenue, healthcare 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 Montréal 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 one-time costs over the next two quarters, which are anticipated to be approximately CAD 500,000 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 CAD 68 million of additional borrowing capacity on our revolving line of credit, and with an additional CAD 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 Para-Net, 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 healthcare revenue for an overall increase in consolidated revenues of 18%. Consolidated EBITDA increased in the quarter to CAD 17.7 million from CAD 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 UK 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 2023 increased by CAD 4.2 million to CAD 6.7 million, compared to CAD 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 2023 increased by CAD 3.1 million to CAD 32.9 million, compared to CAD 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 2023 increased by CAD 0.7 million to CAD 8.8 million, compared to CAD 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 2023 increased by CAD 0.5 million to CAD 6.6 million, compared to CAD 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 2023 increased by CAD 0.2 million to CAD 10 million, compared to CAD 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 2023 increased by CAD 0.2 million to CAD 1.4 million, compared to CAD 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 2023 increased by CAD 0.6 million to CAD 3 million, compared to CAD 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 2023 increased by CAD 0.6 million to CAD 3.2 million, compared to CAD 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 2023 increased by CAD 0.6 million to CAD 3.3 million, compared to CAD 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 2023 was CAD 11.2 million. The company paid out CAD 0.3 per share in dividends during the quarter for total consideration of CAD 3.2 million. The corporation had net working capital of CAD 39.6 million at September 30, 2023, compared to its working capital position of CAD 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 CAD 125 million and a further CAD 25 million accordion for growth purposes. At the end of Q3, we had an undrawn balance of close to CAD 68 million on our operating line and the additional CAD 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 CAD 63.6 million to CAD 55.2 million, and was primarily due to the change in working capital items. Our debt-to-EBITDA ratio, excluding leases, was just under 1.5 times. 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 healthcare and hospitality segments. Our healthcare segment remains steady, and our hospitality segment continues to see good levels of activity with the 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 Para-Net, and believe they will further enhance K-Bro's growth profile. The events of the past three years have 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 will continue to be disciplined as we evaluate acquisitions. 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 fifteenth, we announced a normal course issuer bid to purchase up to 881,000 common shares during the twelve-month period commencing May eighteenth, 2023, and ending May seventeenth, 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 CAD 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.
Thank you. Ladies and gentlemen, we'll now begin the question and answer session. Should you wish to ask a question, please press star followed by one. If you'd like to withdraw your question, please press star followed by two. If you're using a speakerphone, please lift the handset before pressing any keys. One moment for your first question. Okay, and your first question comes from Derek Lessard, from TD Cowen. Derek, please go ahead.
Good morning, this is Cheryl calling for Derek. Thanks for taking our questions, and congrats on the strong quarter.
Thank you, Cheryl.
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.
Okay, that's very helpful. Our 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? My follow-up to that is, if we look at business travel specifically, industry data since then suggests 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 fully back to pre-pandemic. Thank you.
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, you know, 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.
Okay, that's very helpful. Thank you. I'll queue.
Thank you.
Your next question comes from Kyle McPhee from Cormark Securities. Kyle, please go ahead.
Hello, everyone. First question regarding the facility consolidation, moving your Montréal 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, you know, beyond the CAD 500,000 of costs, one-time 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 one-time costs of approximately CAD 500,000, which will happen over the balance of this year and into Q1. 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. We would expect operating efficiencies to result in the back half of the year in the Villeray facility.
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 IDed and are moving forward with.
... Got it. Is it, you know, fair to say with all these synergies in hand, kind of back half of next year, that you should be, you know, starting to push over the you know, 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.
Okay, thank you. Do you have more site consolidation plans, specifically in the Québec City area? I think you now have two sites out there after the Para-Net deal.
We do not have any plans at the moment to consolidate those two operations, and it remains to be a conversation and a discussion we have. But at this point, we expect to maintain two facilities and are assessing the market and the growth potential in that market.
Okay, thank you. 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 kick that over to you.
Yeah, absolutely. Mainly just the ongoing maintenance and strategic CapEx that we had previously disclosed. 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 CAD 8 million annually.
Okay, thank you. That's it for me.
Thanks, Kyle.
Your next question comes from Michael Glen, from Raymond James. Michael, please go ahead.
Okay, just to go back on to the CapEx, because the number that you give in the MD&A is CAD 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?
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 won't occur in CapEx until 2024.
Okay. And for CapEx in 2024, it would be, like, the CAD 5 million for Villeray and then your regular ongoing maintenance. So that would, which I think you'd usually talk about. Is that eight, or is that CAD 5 million or CAD 8 million for that number? So I'm just trying to get a sense of what CapEx in 2024 might look like.
Yeah, absolutely. So you're right, there'll be the CAD 5 million for Villeray, and then in addition to that, we anticipate spending CAD 8 million in CapEx to support operations similar to what we've disclosed in 2023, as well as an additional one-time GBP 4 million investment in the U.K. And this one-time investment in our Perth location will be made to improve margin and supports significant ROI and capacity growth.
Okay. And for the Para-Net 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 healthcare and hospitality revenue from both of those? Or either one, however-
Yeah
... you can get it.
Go ahead, Kristie.
Yes. So on the Villeray transaction, it'd be about 40% healthcare, 60% hospitality. So just under or just over, sorry, 1/3, 2/3. And on the Para-Net, it would be fairly similar, about 50/50.
Okay. And for organic, I'm just, like, for the organic growth that you're seeing in Canada so far this year on healthcare, I'm just trying to back into what the number might look like. It does look like it's been 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, we're feeling good about growth opportunities on the healthcare segment in a number of our markets, yes.
... Thank you.
Thanks, Michael.
Ladies and gentlemen, as a reminder, should you wish to ask a question, please press star followed by one. Your next question comes from Justin Keywood from Stifel Canada. Justin, please go ahead.
Good morning. Thanks for taking my call.
Morning, Justin.
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 a year and a half ago?
No, certainly no changes to that. I mean, if there were any changes, it 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 two acquisitions in the Québec or Montréal region, trying to understand if there's a broader strategy here, any particular attributes that are compelling for the area and if there's opportunity for additional M&A?
I would say we're very pleased with these two 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 Montréal 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 three-year hiatus, we feel that things are moving in the right direction and are quite excited about it.
Is the pipeline pretty broadly based as far as geographies?
Key focus is Canada and the U.K., but, you know, 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, thanks. And then a question for Kristie. I think I heard 1.5 times leverage, if you can verify that, and then also the pro forma net debt to EBITDA and capacity post the recent transactions.
Yeah, it was just, it was just under 1.5, 1.5 times, Justin, and I guess in terms of capacity, post Villeray, we had about CAD 68 million undrawn on the line of credit before the acquisition of Villeray, so, you know, roughly 58 left. And the acquisition of Villeray would bring the funded debt to EBITDA level of to around 1.5 times.
What's the comfort level?
Probably 2, 2-3 times. Oh, sorry, go ahead, Linda.
Yeah. Nope, nope. That was what I was gonna say as well.
Okay, great. Thank you for taking my questions.
Thank you, Justin.
We have a follow-up question from Derek Lessard, from TD Cowen. Please go ahead.
Hi. Thanks, Linda and Kristie. I just wanted to circle back on labor. You noted that some markets are stabilizing, and just wondering if you could highlight any sequential improvement from last quarter and any markets that you are particularly seeing the improvements and those that you feel are still under pressure.
I, 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. 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.
Awesome. And then, last one from 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 there would be more normal contractual increases that take into account increases in labor and increases in general inflation. So most of our, all of our, the high percentage of our one-time increases have are reflected in the results.
Okay, that's very helpful. Thanks again.
We also have a follow-up question from Michael Glen from Raymond James. Michael, please go ahead.
Hey, so coming off of the Q3 in the hotel business, Q4 is always seasonally slower in that segment. But for example, I'm just gonna ask you to get a little bit specific with the guidance for Q4, like the 8, the 8, CAD 18.4 million in Canada in hotel. Like, what's realistic to think about for Q4? Just thinking about everything that's going on.
You know, we still are seeing strong activity, and so I would say we expect to, you know, be double digit over last year.
Okay. Okay, so and that would be pretty much the same between both Canada and the U.K., I guess?
Yes. Yeah.
Okay. Thank you.
We have another follow-up question from Kyle McPhee from Cormark Securities. Kyle, please go ahead.
Thank you. 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, you know, locking in the lower gas prices over a longer period of time at this point, given all the turmoil on, on that side of the world?
To your point, our hedge in the U.K. comes off at the end of 2024, and we are definitely looking at extending our hedges since there has been some reduction in costs in that geography. Yes, it's something that we are looking to move forward with.
Okay, thanks for confirming that.
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. 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.