Colabor Group Inc.

Lionel Ettedgui - President and CEO Jean-François - CFO and SVP

Derek Lessard - TD Securities

Good morning, everyone. And welcome to Colabor Group's 2018 second quarter conference call.

This is Lionel Ettedgui, President and Chief Executive Officer. With me today is Jean-François, Senior Vice President and Chief Financial Officer of Colabor.

Earlier this morning, we issued our second quarter result press release. It can be found along with our financial statement and MD&A on our website and on SEDAR.

Please note that the presentation is also available on our website at www.colabor.com under the Investor Events & Presentations section. First, let me talk to you about our distribution segment.

As expected, the anticipated loss of volume in our Broadline Distribution activities in Ontario, continue to weigh on our results and accounts for most of this quarters challenges. However, we are starting to see some benefits from sales force investment made in our Broadline Distribution activities in Eastern Quebec.

Our aim was to raise our profile within higher value markets such as hotels, restaurants, and institutional market. As a result, we have reinforced our presence at the market and our being more competitive.

This translated into an increase in the volume of sales and improvement on our gross margins in the second quarter. The recent renewal of an important institutional supply contract which include an additional territory is also direct with us of our dedication to grow our share of the market in Quebec.

This successes were somewhat mitigated by higher operating expenses from the underabsorption of fixed cost which put additional pressure on our EBITDA in the quarter. As for the wholesale segment, we lost some sales volume in our specialty and Broadline activities by letting go of non-profitable business.

This reflected well on our gross margin as a percentage of sales and on our bottom-line. This is a result of our efforts to improve procurement cost and inventory management and from a decision to focus on high velocity sales.

I will now turn the call over to Jean-François for a review of our financial results. We will then open the call for questions.

Jean-François?

Thank you, Lionel, and good morning, everyone. Colabor Group's consolidated sales for the second quarter that ended June 16, 2018, stood at $299.9 million, representing a decrease of 9.5% from the equivalent period in 2017.

For the distribution segment, sales decreased by 8.9% to $226.3 million, mostly coming from the anticipated loss of supply agreements for Popeyes Louisiana Kitchen and Montana's BBQ & Bar restaurant chain in our Ontario activities. Sales of the wholesale segments stood at $73.6 million, down 11.3%, resulting from the nonrenewal of non profitable contracts.

Adjusted EBITDA stood at $6.1 million or 2% of sales compared to $9 million or 2.7% of sales in the second quarter of 2017. Here this is mainly the result of the aforementioned loss of volume on our consolidated sales, the fact that in the second quarter of 2017, we reversed a non-recurring provision relating to an executive retention program which reduced our comparable period adjusted EBITDA by $0.8 million and from the under-absorption of fixed costs mainly from our distribution activities in Quebec.

All this was compensated in part by an improvement of margin as a percentage of sales across the organization. Colabor concluded the second quarter of 2018, with net earnings of $0.8 million or $0.01 per share compared to net earnings of $3.1 million or $0.03 per share in the equivalent quarter of 2017.

Our cash flow from operating activities stood at negative $4.1 million in the second quarter of 2018 compared with positive $2.2 million for the equivalent quarter of 2017. This is explained by a higher sequential increase in networking capital during the second quarter of 2018 and lower adjusted EBITDA when compared with the equivalent quarter of 2017.

As at June 16, 2018, the Company's total debt including the convertible debentures and the bank overdraft amounted to $122.4 million, down from $125.1 million during the equivalent period of last year. $39.8 million was drowned from our authorized credit facility of $140 million compared with $28.1 million at the end of last year, leaving us with sufficient flexibility.

Our total debt to trading adjusted EBITDA ratio now stands at 6.2 times compared with a ratio of 4.4 times at the end of the second quarter of 2017. This leverage deterioration is the direct result of a continued declining last 12 month adjusted EBITDA, standing mostly from the performance of our activities in Ontario rather than from the level of debt.

In fact, our current debt level is inline with typical sequential fluctuation between Q1 and Q2 and is even slightly lower than it was at the same time last year. As for the performance of our Ontario activity, we are operating in a busy season with less efficient network following the loss of Montana's business.

We decided to postpone warehouse layout and route delivery change at a later time in the year in order not to disturb our distribution activities during our busiest season and maintain the highest possible level of service. Lionel?

Indeed, Jean-François, if I might add, it is very important for us not to disturb our operations during our busiest season in order to maintain the highest level of customer. Once the summer season is behind us, we will resume our optimization measure with further rightsizing and rerouting initiatives.

This measure should stop providing benefits starting in 2019. Operator, I would now like to open the call over for questions.

Just wondering where you guys are in terms of the updated strategic roadmap, and if we should still expect something, I guess sometime closer to the end of the year?

Well, I think that we have just hired advisors to assist us for a strategic planning. So, we at the moment we're focusing a lot to fix our operation in Ontario in the short-term.

And we're preparing the future regarding the vision and a good way to have differentiation in the highly competitive market.

And you'll be able to give up, I guess say, better sense of -- like the opportunities and kind of some financial metrics attached to that this year?

Later in the year, Derek, yes we're still, that's exactly what we -- the reason why we hired advisors. Yes, later in the year we should be better positioned to open up on that, yeah.

So, there was further margin compression in the Broadline distribution business. I'm was just wondering if you can give us a sense of how much of that do you think is more self-inflicted whether it be the contract losses versus market conditions in terms of competitive activity or what have you.

I mean you did mention that it was -- the different -- while it's a great summer than last year, and you would have expected margins to be up given how crappy it was last year but I think you already mentioned it in your prepared comments that regarding the inefficiency of the business at the moment. But I was just wondering if you could just maybe -- again just what's -- what do you think is self-inflicted versus like competitive activity?

The margin overall in the entire organization are the gross margin, I mean are positive year-over-year. So we're doing good as a percentage of sales, so let me clarify that.

So, now your question is on the EBITDA margin, obviously into the Broadline distribution again in our -- Quebec activities we’re doing better year-over-year, okay. So it's truly related to our entire operation where EBITDA margin are affected.

And, Derek, you have to remember over the last 18 months we lost around $120 million of business with Popeyes and, MTY and Montana's, and we've shut down one DC, okay. And -- so this is truly affecting our EBITDA margin in that region, okay.

We have lived through similar situation in Quebec City, you will remember that in 2013, 2014, and 2015, EBITDA was stressed to a very low level and we overcome all of that issue over two to three years period. So, it takes time when you have such a drastic change in your book of business, reduced volume.

It takes time to redo your routing and warehouse layout. So, it's just a matter of getting back to a more normal absorption of fixed class.

So, that's what we just mentioned. And I think later in the year we'll be in a position to further compress our cost and align our efficiency better.

So, I mean just a follow-up to that. When do you think or where do you think or what inning do you think you're in – with respect to the Ontario optimization whether it's on the volume route optimization?

Not yet. I think at the beginning of 2019, we will be in good shape.

Just to remind you that, on the short-term we have put focus on Ontario regarding rightsizing, which meaning reducing the headcount, a huge cleanup regarding inventory management which means several write-off on inventories. And second step after the high season would be relative optimization, redoing the layout and also to implement new go-to-market strategy regarding sales for Q3 and Q4.

So we'll benefit of all those initiatives in the beginning of 2019.

And I am just going to follow up on your comment regarding the net debt to EBITDA, and again as I see that total debt is coming down. Maybe just wondering what your thoughts are or is the plan to increase EBITDA or pay down debt to address the leverage ratio?

Obviously, Derek, total debt is always increased sequentially from Q1 to Q2 as we get into busy season. So – and year-over-year the debt is lower.

So, obviously we're dedicating our free cash which -- we're still generating free cash flow to reduce debt. And as you would remember, we always generate our free cash flow for the second half of the year.

So, going forward, working capital remains stable and we will generate free cash flow that we'll be able to reduce debt. So, we should end the year with a lesser debt dollars than it was at the year end of 2017.

But definitively the result of this leverage ratio is clearly the direct impact of the adjusted EBITDA performance. And like Lionel mentioned, we're indicated and focused to readdress our situation in Ontario to get the last 4-month EBITDA to go up again, Derek.

That would be definitively -- that's the way to go, is to improve our EBITDA. And by the in Quebec operation, we're not in the same situation.

Pretty much of all of our business unit are doing good. So, clearly we're focused on the Ontario business.

In Ontario, do you see any risk or I guess have you seen any increased competitive behavior as you guys try to kind, skate -- not skate or improve those operations?

No. Honestly, we have seen improvement for the last two periods.

So, we're quite positive regarding that. On the top of that we are hiring talent in Ontario to consolidate the team and we just had one month ago very good talent in operation.

We are very close to fulfill the position of general manager with someone who will know quite well the business. So far we're quite confident on what we're doing, we're on the right path to go back to -- on track for Ontario.

And maybe just one final one from me and it's in respect to the renewal of the contract. Just wondering what it means in terms of sales and – were the renewal terms more favorable?

And maybe just a final one on that is, I'm interested in your comment about getting additional territory. What that means?

First, let me tell you that we're quite transparent with our customer in Ontario. So, we have already renewed several contracts.

We have all their support and we're focusing on trying to keep on having very high delivery and about customer service. Now regarding Quebec, we are growing our market share, we managed to bring organic growth and we have been quite competitive on institutions.

So, we are quite happy with the result we got from all our initiatives with our sales strategies there.

And more specifically, Derek, about the contract we gained and -- we renewed the contract in Quebec, Lionel. And the territory, it's just that it was for an institution for health care in Quebec City, and they expanded the territory which was originally mostly focused on Quebec and eastern.

We had a more central Quebec territory to it. So, it's few -- it's not material enough so we can talk about it, but it's still showing a good - we're doing in Quebec that they renewed the trust they have into us and so we're very happy about this renewal.

I guess the - I don't know if you answered it, but the - like whether renewal terms like, were they more favorable, less favorable, or equal to flat?

We don't want to go in disclosing terms you would understand that. I would say similar terms so we're happy with the contract.

It's a good customer, good contract, we're happy with it.