UniFirst Corp

NYSE:UNF

Earnings Call Transcript 2021-Q2

[Operator]

Greetings and welcome to the UniFirst Corporation Second Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]

It is now my pleasure to turn the conference over to Steven Sintros, President and Chief Executive Officer. Please go ahead.

[Steven Sintros, President and Chief Executive Officer]

Thank you and good morning. I am Steven Sintros, UniFirst’s President and Chief Executive Officer. Joining me today is Shane O'Connor, Executive Vice President and Chief Financial Officer. We would like to welcome you to the UniFirst Corporation conference call to review our second quarter results for fiscal 2021. 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 and 10-Q filings with the Securities and Exchange Commission.

As I have the last couple of quarters, I want to start by saying that first and foremost our thoughts are for the safety and well-being of all those dealing with the impact of the COVID-19 pandemic. Our second quarter results continued to be impacted by the pandemic as well as severe winter storms in Texas and the surrounding states during February. Considering these challenges, we were pleased with the solid results for our quarter.

I want to thank our team partners sincerely for the tremendous effort that they continue to put forth ensuring that they take care of each other and our customers during these challenging times. They truly continue to deliver in every way.

Consolidated revenues for our second quarter were $449.8 million, down 3.2% from the prior year and fully diluted earnings per share was $1.71, down 6% from the prior year. Shane will provide the details of our quarterly results shortly.

Our second quarter began during a time where positive COVID-19 cases were surging and there was strong potential for further economic shutdowns. Cases have sharply declined during the quarter from those peaks and vaccinations have started to pick up creating more stability in our overall operating environment.

That being said, economic activity remains somewhat stagnant and we have yet to see significant recovery activities take hold. This is especially true in the energy dependent markets that we service which have also stabilized, but have not yet begun to recover. We continue to focus on providing our valuable products and services to existing customers and selling new customers on the value that UniFirst can bring to their business.

As we have discussed, the pandemic has clearly highlighted the essential nature of our products and services. We believe the need and demand for hygienically clean garments and work environments positions our company well to support the evolving economic landscape. We continue to position our sales resources to take advantage of the opportunities that exist in the market today and as the economy recovers.

Although our new accounts sales have been solid during the first 6 months of the year and comparable to the first half of fiscal 2020, they are down from the record level set in fiscal '19. The overall impact from COVID-19 as well as sharp declines in activity in the energy dependent markets that we service are contributing to those comparisons. This decline has been partially offset by increased sales to existing customers.

On a positive note, we do expect stronger activity over the second half of the year and from a retention standpoint we are showing marked improvements over the first half of fiscal 2020. Although the trajectory of an eventual recovery is difficult to forecast, we do feel that the improved stability in the overall environment allows us enough comfort to share with you our outlook for the remainder of the year, which Shane will provide shortly. Vaccine optimism continues to be balanced by uncertainty as to when and how quickly the vaccine will create strong positive movement in the economy.

Our solid balance sheet positions us to meet these ongoing challenges presented by the COVID-19 pandemic, while continuing to invest in growth and strengthen our business. As we have talked about over the last year or two, we continue to be focused on making good investments in our people, our infrastructures and our technologies. All of these investments are designed to deliver solid long-term returns to UniFirst stakeholders and are integral components to our primary objective to being universally recognized as the best service provider in our industry.

We continue to make good progress on these core initiatives such as our CRM systems project. We are pleased to report that we have successfully completed several pilot locations and have now officially moved into the deployment phase of the initiative. Our CRM deployment is certainly foundational -- a foundational change to our infrastructure that will allow for service improvements and efficiencies moving forward.

We will continue to invest in our future over the next several years including key investments in supply chain, other technology infrastructure, route efficiency as well as our brand. We will provide additional details as we progress with some of these key initiatives in the quarters ahead.

And with that, I'd like to turn the call over to Shane, who will provide the details of our results for the second quarter.

[Shane O'Connor]

Thanks, Steve. As Steve mentioned, our second quarter of 2021's consolidated revenues were $449.8 million, down 3.2% from $464.6 million a year ago, and consolidated operating income decreased to $40.7 million from $44.1 million or 7.8%. Net income for the quarter decreased to $32.6 million or $1.71 per diluted share from $34.7 million or $1.82 per diluted share.

Our effective tax rate in the quarter was 22.7% compared to 24.2% in the prior year, which favorably impacted the EPS comparison. As a reminder, our tax rate can move from period-to-period based on discrete events including excess tax benefits and deficiencies associated with employee share-based payments.

Our Core Laundry operations revenues for the quarter were $398.2 million, down 3.4% from the second quarter of 2020. Core Laundry organic growth which adjusts for the estimated effect of acquisitions as well as fluctuations in the Canadian dollar was negative 3.6%.

Throughout the quarter, our weekly revenues remained relatively stable as we did not experience any significant headwinds from states, provinces, municipalities or our customers responding to the surge in positive COVID-19 case counts during the holiday period nor did we see any significant tailwind from the impact of the rollout of the COVID-19 vaccines.

Howeveṛ, during the quarter our top line performance was impacted by approximately $2 million from the severe -- from the effect of severe winter storms in Texas and the surrounding states on our operations as well as our customer locations.

Core Laundry operating margin decreased to 8.9% for the quarter or $35.4 million from 9.3% in prior year or $38.4 million. The segment's profitability was negatively impacted by the decline in rental revenues on our cost structure as well as higher health care claims costs. In addition, the lost revenue and additional expense we incurred from the severe winter storms in Texas and the surrounding states reduced our operating income by approximately $2.6 million or $0.10 on EPS. These items were partially offset by lower merchandise and travel related costs.

As Steve discussed, throughout the pandemic, we have maintained our long-term perspective when managing the business, and as a result we continue to invest in our core initiatives including the further development and upcoming deployment of our CRM system.

Energy costs increased to 4.2% of revenues in the second quarter of 2021, up from 4.1% in prior year. This increase was primarily due to additional utility expenses the company incurred related to higher demand during the severe winter storms in Texas and the surrounding states. Excluding those elevated expenses, energy costs would have been 3.9% of revenues as the benefit that we had been seeing over the last several quarters started to moderate with the price of fuel increasing nationally.

Revenues from our Specialty Garments segment, which delivers specialized nuclear decontamination and cleanroom products and services decreased to $35.2 million from $36 million in prior year or 2.1%. This decrease was primarily due to lower activity in the U.S and Canadian nuclear operations, which was partially offset by continued growth in the cleanroom business.

Both periods discussed benefited from significant one-time direct sales, which contributed to strong top line performance in a quarter that is usually negatively impacted by seasonality. The segment's operating margin increased to 14.9% from 12.9%, primarily due to higher gross margin on its direct sales as well as lower travel related costs. These items were partially offset by higher payroll costs as a percentage of revenues.

As we've 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 segment's revenues were $16.3 million, compared to $16.4 million in the prior year. However, the segment's operating profit was nominal compared to $1.1 million in the comparable period of 2020. This decrease is primarily due to reduced sales from the segment's higher margin wholesale business combined with continued investment in the company's initiative to expand its first aid van 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 $509.6 million at the end of our second quarter of fiscal 2021.

For the first half of fiscal 2021, capital expenditures totaled $66.9 million as we continue to invest in our future with new facility additions, expansions, updates and automation systems that will help us meet our long-term strategic objectives. As a reminder, CapEx spend is elevated primarily due to the purchase of a $14.1 million building in New York City in our first quarter of 2020, which will provide us a strategic location for a future service center.

During the quarter, we capitalized $2.2 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 quarter, we had capitalized a total of $27.7 million related to our CRM project.

At this time, we have started a deployment of this application to our numerous locations and anticipate this will continue through fiscal 2022 and into fiscal 2023. As a result, we will start to depreciate the system over a 10-year life in our third fiscal quarter of 2021 with depreciation in the second half of the year approximating $1.5 million to $2 million. [Technical difficulty] for new capabilities, like mobile handheld devices for our route drivers will ramp to an estimated six to $7 million of additional depreciation expense per year.

During the second quarter of fiscal 2021, we repurchased 12,200 shares of common stock for a total of $2.3 million under our previously announced stock repurchase program. As of February 27, 2021, the company had repurchased a total of 368,117 shares of common stock for $61.8 million under the program.

At this time, we believe our ability to project our results has improved. And I would like to take this opportunity to provide an update on our outlook for fiscal 2021. We expect our fiscal 2021 revenues to be between 7 -- $1.793 billion and $1.803 billion, which at the midpoint of the range assumes an organic growth rate in our Core Laundry operations of 3.5%.

As a reminder, the prior year comparison for the second half of fiscal 2021 will be negatively impacted by a $20.1 million large direct sale to a health care customer that we recorded in our third fiscal quarter of 2020. Full year diluted earnings per share is expected to be between $7.30 and $7.65.

This outlook assumes an operating margin in our Core Laundry operations for the second half of the year of 10.4%, and reflects additional expense we expect to incur related to the deployment of our CRM system of approximately $5 million. Just to be clear, this amount includes the depreciation expense that I mentioned earlier.

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 Andrew Wittmann of Baird. Please go ahead.

[Andrew Wittmann, R.W. Baird]

Excuse me, yes, thanks for taking my question, guys. Good morning.

[Steven Sintros, President and Chief Executive Officer]

Good morning.

[Andrew Wittmann, R.W. Baird]

I guess, I wanted to just talk a bit -- a little bit -- I wanted to talk a little bit on the top line trends, you guys say in the quarter no headwinds, no tailwind kind of stable performance marches in the books as of today, Steve, and with another month of vaccine in and people trying to get out a little bit more, are you seeing March pickup over the February levels? And can you just talk about how -- what you saw here this month as it relates to the second half, 3.5% guidance that you just gave?

[Steven Sintros, President and Chief Executive Officer]

Sure. Andy, I think maybe I would characterize mark is mark -- March as a slight pickup from February. Now seasonally typically coming out of the winter months, we have somewhat of a pickup anyway. So, I wouldn't say that we've seen any strong rebound from customer closures, reopening and so on. And talking to some of our team, there's still somewhat optimistic looking forward, but still haven't seen a lot of real activity through March. Obviously, February was a tough month with some of the storms as well. So, things are improved certainly from there. But from a COVID perspective, and we always obviously keep a close eye on the energy markets, no strong movement in March.

[Andrew Wittmann, R.W. Baird]

Are there any leading indicators that you have that, or what are the leading indicators that you're looking at to give you some confidence. I mean, the second half revenue guidance, obviously, it comes against an easier compare and that's probably a big part of it. But what are the things that you're looking at that gives you confidence in that 3.5% outlook, either positively or negatively, maybe there are things that you're thinking could happen that are baked in? Or maybe some of the areas of risk, if you could just kind of talk about some of your factors, that'd be helpful.

[Steven Sintros, President and Chief Executive Officer]

Sure. Yes, when we look at our revenue trends, I guess, compared to 3 months ago, when we decided not to give guidance, I think the concerns back then were of additional shutdowns that might significantly impact the trends, I think with what we're seeing right now, we just have more confidence that those are less likely, obviously, those are things that could impact if things were to shift from -- when you look at our growth metrics, I talked about new accounts sales, we're seeing a little bit better momentum there, as we look towards the second half of the year, retention has been pretty stable. And then we have this population of customers, which we sort of talked about before, that we're staying in close contact with that are either shut down, or significantly reduced services because of the environment. And those are the ones that we feel like we could see some pull for the second half of the year. I will say we haven't built a tremendous amount of it in. But I think any benefits that we may get from some of those customers at least offsets the risk that there could be some further bumps in the road, and make us confident that we should be able to kind of at least maintain sort of the status quo environment. And like you said, a lot of the growth that we're projecting over the second half of the year is really about better comps compared to the third and fourth quarter of last year.

[Andrew Wittmann, R.W. Baird]

Great. That's really helpful. I wanted to ask one other -- on one other topic here. And actually, it turns out that your guys line died a little bit while you're talking about in the script on the CRM. So, I'm going to have you go through that a little bit more, so that we all get that it was -- I think it was a problem on the line that we've at least all of us on our team had. So, I think, I heard that you capitalized in costs $2.2 million on the CRM in the quarter. I think I also heard that you're going to have $1.5 million to $2 million of depreciation in the second half of this year. That's where the line went out. So, if you could talk again, Steve, just reiterate what the annual depreciation number was. I think you said $7 million. But then I heard later in the guidance commentary that there was like a $5 million number. Anyway, I'm throwing out a lot of numbers here. Could you just go through the costs that you're incurring on CRM one more time for this year and on an annualized basis? And when you think that you'll start being able to realize some of the savings from it as well. Sorry, lot there, but that'd be helpful. Thank you.

[Steven Sintros, President and Chief Executive Officer]

Yes, and thanks for pointing that out, Andy, and apologize for the technical difficulty. Just to make sure we're all clear, during the quarter, we capitalized in additional $2.2 million related to the CRM project. At this point in time, we're at the end of our quarter, we capitalized a total of $27.7 million related to that project. Because we're now in the deployment phase, we're going to start depreciating that system within estimated useful life of about 10 years.

So, in the second half of the year, our expectation is that we will incur between $1.5 million and $2 million related to the depreciation of that system. Eventually, the depreciation of that system, we expect to ramp to between $6 million and $7 million, a large part of that is going to be some of the additional hardware that we will install as we deploy our locations related to things like mobile handheld devices that we will put in the hands of our route drivers.

The $5 million number that I quoted later in my prepared remarks, really was the additional expense that we expect to incur related to the deployment of that system in the second half of the year. And that $5 million is -- some of it is lower cap labor. We have been capitalizing some of our internal labor against that project. And as we move into deployment, some of that is actually going to move through the P&L. The depreciation that I had mentioned earlier, the expectations for the year, and then we expect to incur additional costs related to travel and training as we deploy those locations.

[Andrew Wittmann, R.W. Baird]

Okay. That's helpful. Then let's just drill in on that if the second half of this year's $5 million and things like that, I guess that means on an annualized basis that's $10 million. So that as we think about fiscal '22, you've got, I guess, another $5 million wrap, assuming none of the rates of these things increases or decreases. That's the right way to think about how that layers into your fiscal '22 numbers. And given that this system is really supposed to be getting rolled out into '23, like you said earlier on the call, these costs are going to be with you for the next whatever, 18 months or so, is that kind of the right way of thinking about it, Shane?

[Shane O'Connor]

Yes, that's the right way to think about it. We do expect that these could or when we're fully rolling out the system, that these could ramp or be in the $10 million range. We will be ramping up the number of locations that we deploy over the remainder of the calendar year. And some of that experience is going to inform those. As we move along, though, we will continue to update you on our expectations around those numbers. But I think that’s the way you're thinking about it is appropriate.

[Steven Sintros, President and Chief Executive Officer]

And just to be clear, Andy, when we talked about that $10 million or so that could be on top of the depreciation, right? So, the depreciation is just going to come through and end up at $5 million, $6 million a year, it won't hit that rate until you're closer to fully deployed because like Shane said, a bunch of that is the hardware that comes with the deployment. But when you think about the extra costs that aren't depreciation, so it's travel, it's the team's deploying, it's the IT team continuing to support through deployment, that could be in the $10 million range on an annual -- annualized basis. With the bulk of that, the biggest year being 2022 which is next year, and then it's going to bleed over.

[Andrew Wittmann, R.W. Baird]

All right, guys. Those are helpful comments. Thank you. Have a good day.

[Steven Sintros, President and Chief Executive Officer]

Thank you.

[Operator]

Thank you. [Operator Instructions] Our next question comes from Andrew Steinerman of J.P. Morgan. Please go ahead.

[Andrew Steinerman, J.P. Morgan]

Hi, Steve and Shane. So, you mentioned that you haven't seen recovery activity overall, yet. The first thing I want to just clarify, as I assume you mean still growth in the second half of March, just because of year-over-year comps. We haven't seen recovery yet is really just a sequential comment. My second question is, you called out energy as a market that's stable. Are there any other marketplaces, end markets to call out that are either recovering stable or really exceptional in any way? And then my last question is, could you just give any other puts and takes we should think about for the core operating margin being 10.4% in the second half of the year, not related to the CRM system, perhaps with us towards merchandise amortization?

[Steven Sintros, President and Chief Executive Officer]

Okay, very thorough, multi part question. So, I will hit the different pieces. As far as the first piece I think you were talking about, the answer was yes, you're thinking about that the right way. When we're talking about recovery, we're talking more about sequential improvements in customers reopening in the such. You're also correct that March, we started to see declines last year -- in the second half of March. Sọ we're probably getting to the point where some of our revenues are exceeding some of those late March declines. But you're right, the recovery comments are more sequential.

Refresh my memory in the second part of the question. Oh, you are talking about …

[Andrew Steinerman, J.P. Morgan]

Any end market comments that are not related to energy.

[Steven Sintros, President and Chief Executive Officer]

Yes. So, in general, I think we've talked a little bit about that there are places where we're seeing improved activity in and even no [ph] programmers with dentist office, and some other sort of health care applications that have become a larger part of our end market offerings during COVID, in particular. So certainly, there's some strength there. I think you -- we aren't as heavy in food, in beverage, in hospitality, I think you are seeing improvements in that sector. But they're not providing us a tremendous poll, because we're not as heavy in those areas. But we are seeing some slow improvements in those areas.

And then I think when you just look at the broader sectors that we service, whether it's manufacturing or automotive or other, I would go back to that stable comment, but nothing in particular, that's providing a particular poll. As far as the margin questions for the second half of the year, I'll pass it to Shane, because there are a few other items that are impacting.

[Shane O'Connor]

Yes. So, when we take a look at the margins, not only for the second half of the year, but broadly they were the items that were impacting our second quarter, right. We've mentioned for the last number of quarters that we continue to receive a benefit from travel costs. In our -- in this current quarter, that was no difference. As we look towards the second half of the year, we can or we expect that benefit is going to continue at some point in time and our forecast for the remainder of the year has slight increases in that regard as we do think that as the vaccines continue to get rolled out that we will probably start to allow a little bit more travel.

That being said, throughout the pandemic, we do feel around this area, we have learned some things and that the travel in the end probably won't return to the area it was pre-pandemic, right. Clearly during this we've learned that there are very, very capable tools available to us that allow us to work with people face-to-face, whether it be Microsoft teams resume that we will be utilizing and we probably will have a more of a permanent benefit as it relates to our travel expenses. That being said, they will ramp from where they are currently.

From a health care perspective, we sort of called it out in my prepared remarks. This quarter our health care claims cost was high that it was actually higher than it had been for a number of quarters. And in previous quarters, we have been talking about the benefit that we had been receiving, where a lot of discretionary surgeries and other doctor's visits had been put off during the pandemic.

What we believe we're seeing now is maybe some of that pent-up demand as vaccines are starting to get rolled out. And maybe people are becoming a little bit more comfortable with the environment, people are starting to go back to the doctor and we're seeing some increase in the health care claims costs we're experiencing. Throughout the remainder of the year, sort of our quarter -- our second quarter experience has informed some of our forecasts, and we are anticipating that those claims costs are going to be at least elevated from what we've experienced during the pandemic.

You had mentioned merchandise, again, during the last number of quarters, we had been talking about a headwind that we had been experiencing from merchandise. And a lot of that was around the way that we account for the amortization of our merchandise costs. We had articulated the fact that we were putting less merchandise into service. But because we amortize those over an extended period, an average life of 18 months that it was going to take a while before we started to see some of those lower expenses.

During the second quarter, we really hit that inflection point where now all of a sudden, you're starting to see a benefit from merchandise. And in the second half of the year, we expected that benefit is going to continue as the -- I guess the amount of merchandise we're putting into service continues to be favorable. Clearly, during the last, three or four quarters, it's not as favorable as it was maybe during the depths of the pandemic. But we're still putting in less merchandise than maybe we were pre-pandemic. So again, the second half of the year does provide for or does include that merchandise benefit.

[Andrew Steinerman, J.P. Morgan]

Got it.

[Steven Sintros, President and Chief Executive Officer]

One other thing I would add, Andrew, is on energy. I don't know if Shane mentioned that. Energy, certainly when you look at the average cost of a gallon of gasoline right now in the high 2s, 2.80, 2.90, that that compared to our previous sort of internal projections is providing some headwind for the second half of the year compared to the second half of last year, which during, again, the depths of the pandemic, cost of a gallon of gasoline on average is probably below $2, at least for part of that time last summer. So, you will see an energy pick up as well.

[Andrew Steinerman, J.P. Morgan]

Got it. Okay. Thank you.

[Operator]

Thank you. [Operator Instructions] The next question comes from John Cummings, Copeland Capital. Please go ahead.

[John Cummings, Copeland Capital]

Hi. Good morning. Thanks for taking the question. We wanted to get an update on your dividend philosophy. I’m just trying to understand if you plan on increasing or evaluating the dividend on an annual basis? And then also [multiple speakers] any comments you can make in terms of like a target payout ratio or goal with the dividend?

[Shane O'Connor]

Yes, thanks for the question. I mean, we -- over the last few years, we have had a couple of step ups in the dividend. And our commentary to this point was that we will continue to evaluate on an annual basis and look at increases somewhat commensurate with increases in our free cash flows. Now obviously in the -- over the last year with the pandemic, it's been a bumpy year, but it will be something as things smooth out that we'll continue to look at. We don't have a formal communicated policy in place right now. But it is something you can count on us looking at it on an annual basis and evaluating.

[John Cummings, Copeland Capital]

Okay. Excellent. And one follow-up on the balance sheet. The cash creation continues to increase. I'm just curious, at what point would you look to actively return some of that cash either via a special dividend or a buyback?

[Shane O'Connor]

Yes, we had have, I guess, a buyback program in place. And over the course of the last quarter, we've purchased a small amount of stock back. It's also something we'll continue to evaluate based on our comfort level around the trajectory of the business here going forward coming out of the pandemic as well as other plans we may have for that capital. So, again, similar to the dividend it's something we will take a look at. We probably put the brakes on it a little bit during the pandemic, and it will be something we'll continue to evaluate going forward.

[John Cummings, Copeland Capital]

Thank you.

[Shane O'Connor]

Thank you.

[Operator]

And gentlemen, that was our final question. I will turn the call back over to you.

[Steven Sintros, President and Chief Executive Officer]

Great. I would like to thank everyone for joining us today to review our second quarter financial results. We look forward to speaking with you again in June when we expect to be reporting our third quarter performance. Thank you and have a great day.

[Operator]

This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.