UniFirst Corp

NYSE:UNF

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Third 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 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. I’d like to welcome you all to UniFirst Corporation’s conference call to review our third quarter financial results for fiscal year 2018 and to discuss our expectations going forward.

This call will be on a listen-only mode until I complete my 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. I refer you to our discussion of these risk factors in our most recent 10-Q and 10-K filings with the Securities and Exchange Commission.

I am happy to report that UniFirst third quarter produced solid results for our company and our shareholders. Overall revenues for the quarter were an all-time high coming in at $427.4 million, up 4.3% from last year’s third quarter.

Fully diluted earnings per share were $1.85 for the quarter compared to $1.19 per share that was reported a year ago. Our EPS comparison to the prior year was once again significantly impacted by the recent U.S. tax reform which Shane will be elaborating on in a few minutes.

Additionally a year ago we incurred a $5.4 million expense related to the acceleration of stock compensation associated with the passing of our former Chief Executive Officer. Excluding this accelerated stock compensation expense for the prior year, income from operations increased 6.6% for the quarter.

Our Core Laundry operation which makes up the vast majority of UniFirst’s overall business reported record revenues of $375.1 million for the third quarter, up 3.3% from the prior year. Operating income for this segment also grew nearly 3% after adjusting for the prior year for the charge related to the accelerated stock compensation I discussed a minute ago.

Our Specialty Garments segment which delivers specialized nuclear decontamination and cleanroom products and services contributed nicely to our overall results for the quarter. The segment exceeded expectations with solid top and bottom line results, driven by increased nuclear customer business in our Canadian markets, further developing and strengthening long term business relationship with our large power reactor customers north of the border.

Accordingly our Specialty Garments segment is on pace to report strong result and solid improvements for the full fiscal year when comparing the fiscal year 2017. And to round out our results for the third quarter, our First Aid and Safety Segment also reported solid top and bottom line improvements over the same quarter last year.

Overall we are pleased with our third quarter financial performance. I would like to sincerely thank our thousands of team partners throughout North America, Central America and Europe for their continued commitments to our customers and to our company, and for all their hard work to help produce positive financial results for the quarter in the first nine months of the year.

Going forward we’ll continue to rely on our people to demonstrate their unwavering dedication to our customers and to consistently exceed their service expectations, that’s because we know these are the minimum requirements for us to achieve our long term growth goals.

To further drive our organic growth rates, we’ll continue to be challenging our professional sales organization both on a local and national level to continue their year-over-year sales improvements, which are on pace to achieve a record high in fiscal 2018. We’ll also be expanding some new sales initiatives, specifically designed to more effectively add ancillary products and services into existing accounts.

As we look forward, specifically to our fourth quarter and into fiscal ‘19, we are excited about the opportunities that lie ahead. However we also expect the ongoing low unemployment economy to result in related headwinds for us to overcome, including staffing and recruiting challenges, as well as the related salary and wage pressures. We also expect to face cost implications associated with rising merchandise and energy costs.

In addition, we’ll continue to make investments in our people our technologies and our overall service infrastructure in pursuit of the ultimate objective to be universally recognized as the top service provider in the industry. We believe these investments will aid new customer acquisition, as well as retention resulting in long term value to our shareholders.

With that, I’d like to turn it over to Shane who will provide additional details on our quarterly results, as well as our outlook for the remainder of the year.

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

Thanks Steve. Third quarter revenues were $427.4 million, up 4.3% from $409.8 million in the prior year period.

Operating income for the quarter was $47.1 million compared to $38.8 million in the same period a year ago. Our operating income in the prior year included $5.4 million of stock compensation expense related to the accelerated vesting of restricted stock for our former CEO, Ron Croatti. If we reconcile out the effect of the accelerated vesting, operating income grew 6.6% when compared to the adjusted prior year period.

Net income for the quarter was $36.4 million or $1.85 per diluted share, up from $24.4 million or $1.19 per diluted share reported in last year’s third quarter. Excluding the effect of the accelerated vesting I previously discussed, our adjusted net income would have been $27.7 million or $1.36 per diluted share in the third quarter of 2017.

The comparison of our prior year adjusted earnings per share to our current results was impacted by a number of key items. Our provision for income taxes in the third quarter of 2018 benefited from $1.9 million or $0.10 per diluted share of discrete adjustments primarily related to tax credits we recognize in the quarter, as well as excess tax payments from share based payments associated with the adoption of ASU 2016-09 in the first quarter of fiscal 2018.

Also in the third quarter of 2018, as expected and contemplated in our previously provided outlook, our provision for income taxes was positively impacted by tax reform, which resulted in a benefit of $5.2 million or $0.27 per diluted share in the quarter. In addition our diluted earnings per share benefited by $0.06 from the previously announced $146 million repurchase of common shares from the Croatti family in March of 2018.

Our Core Laundry operations which make up approximately 90% of our total business, reported revenues for the quarter at $379.1 million, up 3.3% from the revenues achieved during last year’s third quarter. Organic revenue growth, which adjusts for the estimated effect of acquisitions, as well as fluctuations in the Canadian dollar was 1.9%.

During the quarter we continued to benefit from strong new account sales which were partially offset by higher lost account compared to a year ago. In addition, as we have discussed previously, in the second half of fiscal 2017 we benefited from the timing of certain positive price adjustments and collection of merchandise recovery charges. As anticipated, the Core Laundry organic growth rate slowed when compared to the previous sequential quarter as those benefits annualized.

Core Laundry operating income was $40 million for the quarter compared to the prior year operating income adjusted for the effect of the accelerated vesting I previously discussed of $38.9 million. The Core Laundry operating margin slightly decreased to 10.5% in the quarter compared to the adjusted operating margin in prior year of 10.6%.

We continue to be impacted by wage pressure within our production and service and delivery position, which resulted in higher payroll costs as a percentage of revenue. In addition higher depreciation expense and energy costs provided additional margin pressure during the quarter.

Energy costs increase to 4.4% of revenues in the third quarter of 2018, up from 4.1% a year ago. These unfavorable comparisons were mostly offset by lower healthcare claims, as well as favorable workers compensation expense compared to the prior year period.

As we discussed previously, we experienced abnormally high healthcare and workers compensation claims in the second half of 2017 and were concerned that there might be a similar trend in the second half of the 2018; however, our claims experience was significantly better than both the prior year period, as well as our expectations coming into the quarter.

Our Specialty Garments segment which delivers specialized nuclear decontamination and cleanroom products and services set a new segment record this quarter for both revenues and operating income and exceeded our expectations on both accounts. This performance was driven by strong contributions from its Canadian and European customers, as well as its cleanroom division.

For the third quarter of 2018, Specialty Garments revenues were $34.1 million, up $4.2 million from the same quarter in prior year. This segment’s operating income increased to $5.6 million, up from $4.2 million reported in prior year or 33.7%.

As we’ve mentioned in past quarters, 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 reported revenues and operating income of $14.3 million and $1.5 million respectively for the quarter, compared to $12.9 million and $1.1 million for the same period in fiscal 2017. The top line improvement was fueled by a strong performance in the segments wholesale distribution business, as well as a business acquisition made in the third quarter of fiscal 2017 that strengthened our presence in the Atlanta, Georgia market.

UniFirst continues to maintain a solid balance sheet and financial position. At the end of the third quarter of 2017, cash, cash equivalents and short term investments totaled $238.5 million, down from $349.8 million at the end of fiscal 2017. This decrease is primarily due to the $146 million share repurchase I discussed about, as well as $38.5 million spent on the acquisition of business.

We continue to invest in capital projects that will help us meet our long term strategic objectives, including new facility editions, expansions, updates and automation systems. For the first nine months of fiscal 2018, capital expenditures totaled $88.9 million and we now expect capital expenditures for the full fiscal year to be approximately $110 million.

I’d now like to take this opportunity to provide an update on our outlook for fiscal 2018. At this time we expect our fiscal 2018 revenues to be between $1.68 billion and $1.687 billion and full year diluted earnings per share to be between $7.95 and $8.05. The increase in the revenue and EPS outlook is partially due to the stronger than expected performance in our Specialty Garments business in the third quarter of fiscal 2018.

This outlook now assumes that organic growth in our Core Laundry business will rebound to approximately 4% in the fourth quarter. As we have mentioned in the past, our organic growth rates can be impacted from quarter-to-quarter based on the timing of certain positive price adjustment and our ability to collect on our merchandise recovery charges.

In addition, the outlook assumes an operating margin in the Core Laundry business for the fourth quarter of 10.2% at the midpoint. The operating margin anticipates continued margin pressure from energy and depreciation expense, as well as additional investment in our support infrastructure and our ongoing technology initiative.

Our outlook assumes an effective tax rate for the fourth quarter of fiscal 2018 of 28.4%. However this rate continues to be dependent upon certain assumptions regarding fluctuations in our deferred tax balances over the remainder of this transitional year.

As a reminder for fiscal 2018, our federal rate will be a blended rate due to the change in tax rates occurring during our fiscal year and we continue to expect that our effective tax rate for fiscal 2019 and thereafter to be generally in the 26% to 27% range.

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

[Operator]

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

[Andrew Steinerman, J.P. Morgan]

Hi, it’s Andrew. I know you said that you expect the fourth quarter or organic Core Laundry to lift above 4%. This third quarter it was 2% and so could you just go over what was holding back growth in the third quarter?

[Steven Sintros, President, Chief Executive Officer]

So Andrew, as we talked about a little bit, some of it was the timing of certain price adjustments we did a year ago versus the way we’re doing them this year. So some of it is just temporary timing of different things we are working through with the customers. So I wouldn’t read too much into the dip. And then the rebound I think, you know we still are sort of trending in that kind of low single digits area and that’s still the take away.

[Andrew Steinerman, J.P. Morgan]

And how were new sales in the quarter?

[Steven Sintros, President, Chief Executive Officer]

New sales, new sales were positive. I think we are running over the course of the year, about 10%, 12% ahead of the prior year in terms of new sales, so new sales are positive. And you know the other items continue to be a work in process, which continue to be you know pricing, adds reduction, selling additional products and trying to improve our retention metrics.

[Andrew Steinerman, J.P. Morgan]

And just lastly, and right now would you describe the environment for pricing as constructive?

[Steven Sintros, President, Chief Executive Officer]

I would say it’s constructive. I would say it’s constructive, but at the same time it remains competitive. I don’t want to send the message that we think it’s been a big uplift. I know there’s a lot of discussion on the consolidation. I think the consolidation has improved the environment in certain aspects, but it remains competitive.

[Andrew Steinerman, J.P. Morgan]

Great, thank you.

[Steven Sintros, President, Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from the line of Tim Mulrooney with William Blair. Please proceed with your question.

[Tim Mulrooney, William Blair]

Good morning.

[Steven Sintros, President, Chief Executive Officer]

Good morning.

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

Good morning.

[Tim Mulrooney, William Blair]

Just a book keeping question at first Shane, how much did acquisitions contribute to growth, to revenue growth in the third quarter and how much do you expect them to contribute to total revenue growth in the fourth quarter. I’m trying to reconcile your guidance.

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

So in the third quarter of ‘18, acquisitions contributed about 1% to the growth in our Core Laundries and in the fourth quarter we are anticipating a similar type of benefit from acquisition related growth.

[Tim Mulrooney, William Blair]

Got it, okay thank. And just one more from me, I mean given where your plants are located, you guys maybe have a stronger presence in oil related geographies and higher exposure to energy generally. Can you talk about what you are seeing there in a little more detail, say over the last couple of months relative to the last year? Has there been a material pick up in [add stops] [ph] in those locations or just anything you could point to for us.

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

Sure, I’d say – I wouldn’t probably describe it as material. We are seeing – if any market is seeing some notable rebound, it’s West Texas and the Odessa market for us. The other energy markets are stable and showing some signs of positive adds, but I wouldn’t categorize the rest of the market as being significant. Odessa is having a pretty good bounce back year, but we haven’t seen it spread out as far into some of the other markets like your Oklahoma City and Corpus Christi or even Western Canada. Again, maybe we’re seeing some of the seedlings of it, but nothing significant yet.

[Tim Mulrooney, William Blair]

Okay, great. Thank you.

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

Thank you.

[Operator]

Our next question comes from one of Justin Hauke with Baird. Please proceed with your question.

[Justin Hauke, Robert W. Baird]

Good morning guys.

[Steven Sintros, President, Chief Executive Officer]

Good morning.

[Justin Hauke, Robert W. Baird]

This is Scott. Good morning. I guess I’ve got two here. One more on the organic growth; just another point that you brought up in the prepared remarks. I think you mentioned that you know maybe the retention rate dipped a little bit. So I just wanted to understand if that was something specific for the quarter or if that’s going to be something that will continue to drag on the contribution for the next couple of quarters.

[Steven Sintros, President, Chief Executive Officer]

So our retention can ebb and flow from quarter-to-quarter, year-to-year. We definitely don’t – we ordinarily don’t stray too far from kind of our baseline and this year it’s picked up a little bit and the third quarter was a little bit higher than what we had been running. On a percentage basis it’s not – you know it’s not more than 0.5% on revenues, but it’s a little higher than we’d like to see. Will there continue to be a drag? Well, as you know any business you lose in a particular quarter kind of helps set the stage for the next quarter, but we don’t see it necessarily as the trend that we expect to continue.

[Justin Hauke, Robert W. Baird]

Okay, great, thank you. And then I guess the second question I had, on the acquisition and thank you Shane for quantifying that, but it looks like there was an incremental acquisition in the quarter, maybe $16 million or so that you spent. Where was that? What segment? And maybe just any detail on kind of what you’re seeing in the market there?

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

Sure. So there were a couple of small pieces in the U.S. laundries in the quarter. What was a little bit maybe more unusual is we did expand about $8 million in the quarter on a group of small acquisitions in the nuclear industry. They are related companies that kind of joined together to form a small competitor of ours and so we did purchase that during the quarter of about $8 million.

We do think that will help us going forward in some of the markets there, down in the southern part of the country. So that combined with some of the smaller laundry related acquisitions made up the balance for the quarter.

As far as what we see out there, it seems like maybe the environment’s a little bit more active, but you know again, as you know these transactions are generally driven by family situations as opposed to an environment that might be more conducive you know to consolidation. So the ones we are seeing kicking around are more facts than circumstances. Not sure there’s anything that’s driving it in particular.

[Justin Hauke, Robert W. Baird]

Great. Thank you very much guys. I appreciate it.

[Operator]

[Operator Instructions] Our next question comes from the line of Kevin Steinke with Barrington Research. Please proceed with your question.

[Kevin Steinke, Barrington Research]

Good morning. So on the guidance you mentioned, that the increase in both revenue and EPS guidance is partially due to stronger than expected performance in Specialty Garments. Could you kind of maybe quantify or you know at least give a rough proportion of how much of the guidance increase is attributable both to our Specialty Garments and you know where the rest of the guidance increase is coming from?

[Steven Sintros, President, Chief Executive Officer]

Yeah. So as we were looking into the third quarter, we were expecting nuclear to have a strong quarter, but as I had mentioned in my comments, nuclear outperformed our expectation. From a top line perspective, they exceeded by about $5 million to $6 million and from a profitability perspective, you know their performance compared to our expectations acquitted to about $0.10 to our EPS.

When you take a look at the other factors that were driving I guess our performance compared to maybe what we originally expected, I had mentioned the fact that there were some discrete tax items in the quarter related to both the ASU adoption earlier in the year, as well as some tax credits that we recognized that equated to about $0.10 of EPS.

And then other than that, when we take a look at the performance for the quarter, for the most part aside from those items, a lot of the I guess the headwinds that we were anticipating, the wage pressures, the increase in energy, the depreciation expense, for the most part those were anticipated. The item that really was unanticipated and I sort of spoke to it a little bit was the performance of our healthcare and our workers comp claim.

The end of – or in the second half of 2017, we’ve talked about it a number of times. We have very, very high healthcare claims and we were cautious going into the second half of ‘18 that we might have a similar trend, and that was reflected – that caution was reflected somewhat in our outlook.

For the third quarter our healthcare claims and our workers comp came in lower than our expectations, and for the most part really makes up the delta between the two items I previously mentioned, the discrete items and the nuclear beat [ph] and our performance improvement for the quarter.

[Kevin Steinke, Barrington Research]

Okay, great, that’s very helpful. And I noticed also in terms of the Core Laundry operating margin, you said expecting 10.2% at the midpoint in the fourth quarter; you know previously you talked about maybe 9.5%. So are you just now assuming that again maybe the healthcare and workers comp claims won’t be as high as you had previously expected or what’s contributing to that margin, you know a bit of an increase there in terms of the outlook?

[Steven Sintros, President, Chief Executive Officer]

Yeah, the primary driver behind the improved margin outlook for our fourth quarter is you know revised expectations as it relates to our revenue growth. It’s really obviously that revenue growth is providing some favorable margin benefits. Now those are being offset by you know pressures that we are expecting related to sort of the pressures that we’ve been speaking to and we continue to feel – we still expect that energy is going to be a headwind, as well as depreciation expense. But the main thing that’s driving the improvement over my previous guidance would be the improved revenue performance.

[Kevin Steinke, Barrington Research]

Okay, that’s helpful. And in terms of that 4% growth again, following up on that, I mean I think you mentioned maybe just timing or price adjustment. So I don’t know if you could speak to that a little bit more in terms of what you know, there’s a shift in strategy there or why the changes to maybe timing of some of those price adjustments.

[Steven Sintros, President, Chief Executive Officer]

I think we probably don’t want to get into too much detail there, but just needless to say, we were always evaluating when the right time is to work with our customers on pricing in terms of cost pressures and energy pressures and other types of things, and so that timing can vary over the years and have some impact, but you know overall nothing too out of the ordinary.

[Kevin Steinke, Barrington Research]

Okay. I guess lastly just on Specialty Garments, you mentioned I think some new business there, some strength in relationships with existing customers. I’m just curious, as see you look at that business long term, do you think of that as a growth business? I mean really what’s the market opportunity there in terms of winning new customers or getting more business with existing customers, just you know how you think about that Specialty Garments market overall?

[Steven Sintros, President, Chief Executive Officer]

I think there’s some expansion opportunities, particularly internationally where we continue to look at new customer acquisition in Europe in particular. In the U.S. we continue to try to work with new customers, as well as expand the services that group provides.

I think we have made some head roads into Canada with some large customers and you know I think that businesses is so dependent on – although we do try to obviously improve and expand our customer base, some of those customers and the timing of some large projects they have going on really drive you know the volume coming through that, and you know I think this year was a very strong year and it’s going to provide some more difficult comps for next year, but we are fully confident that it’ll continue to be solid results in that segment with some larger projects coming down the road.

[Kevin Steinke, Barrington Research]

Alright, sounds good. Thanks for taking the questions.

[Steven Sintros, President, Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions] Mr. Sintros, there are no further questions at this time. I will now turn the call back to you.

[Steven Sintros, President, Chief Executive Officer]

Okay, thank you. I’d like to thank everyone for joining us today to review our third quarter results for fiscal ‘18. We look forward to speaking with you again in October when we expect to be reporting our year end results and our outlook for fiscal ‘19.

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.