UniFirst Corp

NYSE:UNF

Earnings Call Transcript 2020-Q1

[Operator]

Greetings! And welcome to the First Quarter Earnings Call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions].

I would now like to turn the conference over to Mr. Steven Sintros, UniFirst’s President and Chief Executive Officer. Please go ahead, Sir.

[Steven Sintros, President, Chief Executive Officer]

Thank you and good morning. I'm Steven Sintros, UniFirst’s President and Chief Executive Officer. Joining me today is Shane O'Connor, Senior Vice President and Chief Financial Officer. We'd like to welcome you to UniFirst Corporation's conference call to review our first quarter results for fiscal year 2020 and to discuss our expectations going forward.

This call will be on a listen-only mode until we complete our prepared remarks; but first, a brief disclaimer.

This conference call may contain forward-looking statements that reflect the company’s current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties. The words anticipate, optimistic, believe, estimate, expect, intend, and similar expressions that indicate future events and trends identify forward-looking statements. Actual future results may differ materially from those anticipated depending on a variety of risk factors. For more information, please refer to the discussion of these risk factors in our most recent 10-K filings with the Securities and Exchange Commission.

I'm happy to report that UniFirst’s first quarter of fiscal year 2020 produced solid results for the company relative to both our top and bottom line. Shane will go into the details shortly, but I wanted to first take a moment to step back and recap the quarter's results.

For the first quarter of 2020 UniFirst set record highs for both revenues and profits. Consolidated first quarter revenues were $465.4 million, an increase of 6.1% over the same quarter a year ago. Meanwhile, operating income and net income were $60.1 million and $48.2 million respectively, representing increases of 19.2% and 25.9% when compared to the first quarter of last year. As always, I'd like to acknowledge that we do not achieve our company successes alone.

That said, I want to take this opportunity to thank those who are so critical to UniFirst’s day-to-day accomplishments. Our 14,000-plus employee team partners throughout North and Central America and in Europe who work so hard week in and week out to take care of our customers, each other and our company.

Our strong first quarter results were primarily influenced by our core laundry operations which make up approximately 90% of our overall revenues and operating income. With respect to the primary growth drivers of this segment, the quarterly results were largely positive, but there were some areas of caution to be noted as we look over the remainder of the year.

During the first quarter, new account sales exceeded the strong first quarter sales we achieved in fiscal year 2019. However, December activity combined with future sales projections have our second quarter new sales expectations softening when compared to the first quarter in prior years activities.

In addition, our additions versus reductions metric, which measures wearer levels within existing accounts trended negatively compared to the prior year. Both of these trends are partially due to reduced business activity in the energy dependent markets that we service.

We've used this term energy dependent markets in the past to describe those geographies in the United States and Canada that have a significant portion of their economic activities tied to the oil and gas industry. Of course, as always, an ever changing macroeconomic environment makes it difficult to predict exactly how long and to what extent this trend may persist.

In addition, overall customer retention slipped some in the first quarter, partially related to select large accounts where we made the economic decision not to renew our service agreements. We expect these developments to make for more difficult topline comparisons for the remainder of the year when comparing to what was a strong fiscal year performance in 2019 for new account sales and customer retention.

In the meantime, we'll continue to focus on executing on our strategic plan, which includes defined goals for improving customer service and retention, sales organization effectiveness and retention of our employee team partners.

As far as our other business segments go, Specialty Garments which provides specialized work-wear and niche services for nuclear and clean room industries and our first aid and safety division, both contributed positively to our overall results of the first quarter.

Looking forward, we remain committed to maximizing our results and delivering long term value to our shareholders and our team partners. We’ll achieve these ends with a continued focus on strengthening customer loyalties in growing our base through excellent and personalized business services and continued investments in our service production and sales teams.

Our customer focused philosophy remains at the core of our company's success today. Our strong balance sheet, healthy cash position and ongoing cash flows allow us to continue making solid investment in all principal areas of our business, as well as to be competitively pursue business acquisitions that make business sense; all helping us to meet our primary long-term corporate objective to be universally recognized as the best service provider in our industry.

And with that, I'd like to turn the call back over to Shane, who will provide the details of our results for the first quarter and our outlook over the remainder of fiscal year 2020.

[Shane O’Connor]

Thanks Steve. As Steve summarized, in our first quarter of 2020 consolidated revenues were $465.4 million up 6.1% from $438.6 million a year ago, and consolidated operating income increased to $60.1 million from $50.4 million or 19.2%.

Net income for the quarter increased to $48.2 million or $2.52 per diluted share from $38.3 million or $1.99 per diluted share. Our core laundry operations revenues for the quarter were $416.3 million, up 6.6% from the first quarter of 2019. Core laundry organic growth, which adjusts for the estimated effect of acquisitions, as well as fluctuations in the Canadian dollar was 6.0%.

During the quarter, our organic growth continued to benefit from the solid new account sales and improved customer retention in fiscal 2019, as well as the improved collection of merchandise recovery charges.

In addition, our core laundry revenues in the quarter benefited by approximately 0.7% from the impact of certain revenue adjustments related to our credit reserves, as well as the timing of revenues around the Thanksgiving holiday. Both of these timing items resulted in a benefit to our first quarter revenues, but are expected to have very little impact on our performance for the full fiscal year.

Core laundry operating income was $53.8 million for the quarter, up from $44.8 million in the prior year, and the segment operating margin increased to 12.9% compared to 11.5% in the prior year. This increase was primarily due to lower energy, selling, payroll and depreciation and amortization as a percentage of revenues, as well as the impact of the revenue adjustment I discussed earlier.

In addition, several other costs trended favorably as a percentage of revenues due to the strong revenue growth in the quarter. These benefits were partially offset by an unfavorable comparison with prior year due to a $3 million pretax gain from the settlement of environmental litigation recognized in the first quarter of 2019, which equated to $0.11 per diluted share.

Energy costs decreased to 3.9% of revenues in the first quarter of 2020, down from 4.2% a year ago. Revenues from our Specialty Garments segment, which delivers specialized nuclear decontamination and cleanroom products and services decreased by 3.0% to $33.4 million in the first quarter. This decrease was primarily due to decreased outage activity in the U.S. and Canadian nuclear operations, which were partially offset by strong growth in our cleanroom operations. This segment operating margin increased to 14.6% from $4.9 million or $4.9 million from 13.0% or $4.5 million in the year ago period.

This increase was primarily due to lower merchandise and production payroll costs as a percentage of revenues, which were partially offset by higher casualty claims expense. As we mentioned in the past, this segment's results can vary significantly from period to period due to seasonality and the timing of nuclear reactor outages and projects that require our specialized services.

Our First Aid segments revenues increased by 15.2% to $15.7 million and its operating income increased by 19.9% to $1.4 million. These increases were primarily due to a strong quarterly performance in the segments wholesale distribution business, as well as the company’s initiative to expand its First Aid band business into new geographies.

We continue to maintain a solid balance sheet and financial position with no long term debt and cash, cash equivalents and short term investments totaling $356.6 million at the end of our first quarter of fiscal 2020.

Cash provided by operating activities for the first three months of the year was $52.4 million, an increase of $20.2 million from the first three months of fiscal 2019. This increase was primarily due to our strong operating performance in the quarter, as well as lower working capital needs of the business. In addition, the quarterly comparison benefited from the pay out of a $7.2 million one-time bonus to our employees in the first quarter of fiscal 2019.

For the first three months of fiscal 2020, capital expenditures totaled $29.0 million as we continue to invest in our future, with new facility additions, expansions, updates from the automation systems that will help us meet our long term strategic objectives.

During the quarter we capitalized $3.4 million related to our ongoing CRM project, which consisted of license fees, third party consulting costs and capitalized internal labor costs.

As of the end of our first fiscal quarter, we had capitalized a total of $14.1 million related to the CRM project. At this time, we still anticipate that sometime in the second half of this fiscal year we will begin piloting at several test locations and that we do not expect to incur any depreciation expense related to this project in physical 2020.

We continue to look for and aggressively pursue additional targets as acquisitions remain an integral part of our overall growth strategy. As we mentioned in our October webcast, in September 2019 we completed an acquisition in Kansas City, Missouri, which significantly increases our presence in that market and is anticipated to contribute approximately $12.5 million in additional revenue to fiscal 2020.

During the first quarter of fiscal 2020, we repurchased 50,600 common shares for a total of $10 million under our previously announced stock repurchase program. As of November 30, 2020 the company had repurchased a total of 247,750 common shares at an average price of $163.43 for $40.5 million under the program.

I'd like to take this opportunity to provide an update on our outlook for fiscal 2020. We now expect that our fiscal 2020 revenues will be between $1.860 billion and $1.872 billion. This guidance has more modest expectations at the high end of the range than previously communicated due to the trends that Steve discussed previously and the related impact on our expectations for the remainder of the year.

We now also expect our full year diluted earnings per share will be between $7.60 and $7.92. This revised EPS guidance continues to assume an operating margin at the midpoint of the range of 10.3%. However, our forecast now includes our revised revenue expectations, slightly improved assumptions for interest income, as well as a lower tax rate for the year of 24.5%.

As a reminder, our guidance for fiscal 2020 includes one last week of operations in our fourth fiscal quarter compared to fiscal 2019 due to the timing of our fiscal calendar and assumes our current level of outstanding common shares.

This concludes our prepared remarks, and we would now be happy to answer any questions that you might have.

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Andrew Steinerman with J.P. Morgan. You may proceed with your question.

[Andrew Steinerman, J.P. Morgan]

Hi. Could you jump a little bit more into the assumptions around the energy end market, and so I definitely understand you're saying it's, you know a more challenging environment for energy companies. Could you be a little more specific? Is this like tied to number of rigs and is there any assumption made by the fact that as you well know, oil prices very recently actually have picked up.

[Steven Sintros, President, Chief Executive Officer]

Sure, Andrew. What we're seeing in terms of some of it is rig counts, some of it is simply and you read the articles in the paper like I have, you know these companies have a lot of debt coming due and they are trying to trim their operations to where they can take advantage of some of those higher prices to pay down debt and we're seeing it in management of the heads within some of those companies. And so, you know over the last couple years after the big dip in energy activity in say 2016, we had seen some strong recovery in West Texas primarily, but now we're seeing softness in really all the energy markets in terms of reducing heads and we don't want to overstate the impact of it.

As you saw, we trimmed the top end of our range and some of that really is in some of those markets. Last year at this time we were at positive [enhanced deductions] [ph], and this year in some of those markets we're negative, and so we're seeing some of that activity right. The recent development around potentially spiking oil prices you know may or may not change that, but we really haven't had enough time to see what the impact of that might be, whether they'll take that additional profit and pay down debt or start reinvesting again, it's probably going to play out over several months.

[Andrew Steinerman, J.P. Morgan]

And could you just remind us what your exposure is to the energy end market.

[Steven Sintros, President, Chief Executive Officer]

So, we've talked about over time that you know oil and gas exploration, depending on what year you were talking about was anywhere from 5% to 10% of our business, but really that's not as much the relevant number as you know the overall geographic exposure that we have to markets that are dependent on oil and gas activity and all the support businesses as well. I wouldn't say we're seeing at this point that depth of an impact down to all the support businesses, but we are seeing the early stages of slowdowns.

[Andrew Steinerman, J.P. Morgan]

Okay, thank you.

[Operator]

Our next question comes from the line of Andrew Wittmann with Baird. You may proceed with your question.

[Andrew Wittmann, Baird]

Hey, great! I just wanted to dig a little bit more into that last question from Andrew and just ask, have you lost specific contracts with these customers or Steve, is this really just a reflection of where levels, adds stops that you're seeing.

[Steven Sintros, President, Chief Executive Officer]

Yeah, I would say Andy that it's a little bit of all the above, but when look at our growth drivers and you say new accounts sales, adds reductions in lost accounts, and again I think I made the comment to say that they were partially due to the oil and gas; we've seen impact in all. When we look at new account activity year-over-year, this time, this year versus last year there were more energy accounts being sold last year at this time. Certainly I just mentioned the adds reduction metric. I wouldn’t say as much of it is in the lost account number. Although there's some, we are seeing some smaller customers failing.

[Andrew Wittmann, Baird]

Got it! I mean I guess when I do the math here, I kind of – it looks like you're somewhere implying for the rest of the year, somewhere in the high, you know around 2%, 2.5% total growth in your organic outlook. If energy is 5% to 10%, call it 7%, I mean from the current rates of underlying organic growth you’d have to see that business get cut in half. So it sounds like – it feels like there is more there and you did mention that you lost one large or maybe several large accounts on a non-economic basis.

So I guess can you talk more broadly beyond the energy patch what you’re seeing and specifically on the large account if you could help us understand the size of that, so that could help us understand the deceleration implied in your revenue guidance.

[Steven Sintros, President, Chief Executive Officer]

So, I think taking a step back, I think the revenue guidance, we have it at the beginning of the year that assumed organic growth for the year of around 4%. We are basically saying that you know we're coming off that a little bit for the trends we are seeing, but we were always assuming some deceleration of organic growth partially due to the tougher comps in a number of areas, partially related to the strong account sales in ’19, but also the higher merchandise recovery charges.

So we always sort of had the model, assuming some deceleration of organic growth that put us at about that 4% mark for the year. Now over the remainder of the year, right now our numbers are a little closer to about 3% organic, which obviously assumes some deceleration. There’s a number of pieces impacting that.

The slowdown in energy is a piece on the adds reduction side. I talked about on the lost accounts side. Last year we had as good of a retention year as we really had over the last decade. Through the first quarter, we are ticking a little higher than that for sure, part of it being some of – you know a couple of these accounts that we made the decision to move away from. I hate to get into too much of the details, but those probably make up a few million dollars of revenue. So it's another item around the edges, but as we always talk about our different growth drivers, it’s an area we felt worth mentioning that retention had slipped some.

On the new sales side, I will say that I made the comment that activity had slowed some in December and through the holidays, and that's having our outlook for Q2 new sales being a little soft. Last year at this time, we really blew through the holidays with very strong activity on the new account side, which really helped fuel a full year new sales result that was by far a record of new account sales, and we're seeing a little bit of slowing right now.

Again, I made the comment partially due to energy, but probably not fully due to energy. So the combination of some of those factors, combined with the originally built in assumption that there was going to be some tougher year-over-year cops as the year went along, is kind of getting us to the results and the guidance that we are putting forth at this point.

[Andrew Wittmann, Baird]

That’s great context. Thank you. I think it's probably also worth noting here that your margins were really quite good and I wanted to dig into that a little bit here as well. I mean you did mention that there's – 0.7% of the growth rate was from accounting items of release and some other stuff there as well, timing. I mean even if – are we to assume that even we were to take that 0.7% or about $3 million, I mean that basically, does that come through as like basically pure profit and even if it does, I mean your margins are still up a lot. Is that the right way to think about what you're calling out there in that 0.7%.

[Shane O’Connor]

Yeah, this is Shane. Yeah, that 0.7%, a fair amount of that drops to our operating margin line. When you take a look at the operating margin impact of those, those equate to about 50 basis points on our margins. So clearly, the lion's share of that is translating into profit, because there's no cost associated with some of those reserve adjustments.

[Andrew Wittmann, Baird]

Okay, and then my last question for now is just - I've never heard the timing of Thanksgiving being a factor in organic growth and so I was just wondering the mechanics behind that? Why is that the case here?

[Steven Sintros, President, Chief Executive Officer]

Yes, I figured that would probably be a question. So again, this sort of relates to our fiscal calendar and actually where Thanksgiving falls this year in the actual calendar. So at the end of our first quarter, Thanksgiving is always the last two days of our quarter and in some cases we're not able to run the routes related to those two days.

And we have to run those routes. Some of those routes we run before the holiday, some of them we run subsequent to the quarter, in the subsequent week which falls into our second quarter. Now historically we've always deferred the revenue related to those routes, because we say the delivery is important enough for revenue recognition. Because Thanksgiving is a week later this year, and it's actually closer to Christmas, we ran more of those routes before the holiday, which results in that revenue being recognized in the first quarter, where normally it would be deferred into the second quarter.

So again, that's a timing item where the revenue got recognized in our first quarter. Normally it would be in the second quarter, so it will actually be a headwind to the comparison in the second quarter, because not as much is deferred there.

[Andrew Wittmann, Baird]

Thank you very much.

[Operator]

[Operator Instructions] Our next question comes from the line of Tim Mulrooney with William Blair. You may proceed with your question.

[Timothy Mulrooney]

Good morning.

[Steven Sintros, President, Chief Executive Officer]

Good morning.

[Timothy Mulrooney]

I had a couple of questions here. So, on the margin side for your core laundry business, correct me if I'm wrong, but I think you were calling for an operating margin of 10.3% at the midpoint for the full-year, is that correct?

[Shane O’Connor]

That's correct.

[Timothy Mulrooney]

Okay, so but with the first quarter being so strong here, I think actually up like 140 basis points year-over-year. Do you have updated expectations for that segment or are you still expecting 10.3% midpoint for the full-year?

[Shane O’Connor]

Yes, I had mentioned that in some of my prepared remarks that the expectations for the full-year still have the midpoint being 10.3%. And the first quarter, it was a very strong profit quarter for us, but it often times is. The first quarter is usually very strong. Some of the cost escalations that we see just seasonally are in the second half of the year, and I guess I'll take the opportunity to speak to a couple of those.

First and foremost, would be we have set annual salary increases that take place in January, obviously with you know payrolls being the lion's share of our costs. Our first fiscal quarter is benefiting from a lot of the revenue growth during the year, but those salary increases don't hit until those last three quarters.

Our second quarter has certain seasonal costs that cause it to almost always be down from an operating margin perspective, and I think historically we've talked about some of these things. They are normal in operating, but – or the resetting of unemployment taxes we have a disproportionate amount of real estate taxes that actually get expensed during that quarter, and we also have a large payout of unused sick time that takes place in that.

Some of the other things that are resulting in the margin being reduced in those last three quarters, we have mentioned the fact that we were forecasting in some additional costs related to our CRM project, and we expect those to be heavier in the final quarters as we move toward pilot and eventually we start to ramp up for deployment, and then of course there's going to be an impact related to the modest revenue growth in the second half, the more modest revenue growth in the second half of the year. I guess the last item...

[Timothy Mulrooney]

Okay.

[Shane O’Connor]

The last item I'll talk about, just because coming into the year we had commented on the fact that we had some expectations around healthcare costs. Starting at the beginning of our fiscal year we actually redid all our healthcare plans to our employees. So our employees were introduced to those new plans, and right now we have one quarter's worth of experience related to those new plan, but there does remain a significant amount of uncertainty around it, I guess the claims experience related to those plan, and the second half of our year is also maintaining caution as it relates to the costs that are going to be associated with those.

[Timothy Mulrooney]

Got it. Okay Shane, yes, thanks for all that extra color; that's really helpful. Maybe one or two more from me. Sticking on your guidance, you pulled up the low-end of your EPS guidance range for the full-year? I think you mentioned in your prepared remarks that was primarily due to a lower tax rate and maybe a more favorable interest expense than you were initially anticipating? Does that make up the majority of why you are pulling that up?

[Shane O'Connor, Senior Vice President, Chief Financial Officer]

It does. It does.

[Timothy Mulrooney]

Okay, and lastly from me, could you just comment on the pricing environment? Is it still pretty favorable? And could you also comment on your merchandise recovery charges. Are you still seeing a benefit there was that more of a 2019 phenomenon? Thank you.

[Steven Sintros, President, Chief Executive Officer]

Sure, I think the price environment is relatively stable. I think it's – I've made the comment before that there’s still a fair amount of aggressiveness in our industry in terms of new accounts and the sales process. With respect to merchandise recovery charges, the first quarter was still pretty strong. The growth in that area was higher than the organic growth was overall, so it was a contributor, and I think we're starting to get to the point where we're annualizing some increases there that also leads to the caution of the second half of the year or the last nine months in terms of tougher comps.

[Timothy Mulrooney]

Understood! Thank you, gentlemen.

[Steven Sintros, President, Chief Executive Officer]

Thank you.

[Operator]

There are no further questions at this time. I will now turn the call back to you.

[Steven Sintros, President, Chief Executive Officer]

Okay, I'd like to thank everyone for joining us today to review our first quarter results for fiscal year 2020. We look forward to speaking with everyone again in March when we expect to be reporting our second quarter and mid-year performances for the year, as well as our expectations for the remainder of fiscal 2020. Thank you and have a great day!

[Operator]

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your line.