UniFirst Corp

NYSE:UNF

Earnings Call Transcript 2019-Q3

[Operator]

Greetings and welcome to the UniFirst Third Quarter Earnings Conference Call. During the presentation all participants will be in a listen-only mode. After that, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Steven Sintros, President and CEO. Please go ahead.

[Steven Sintros, President & CEO]

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 call to review our third quarter results for fiscal year 2019 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-Q and 10-K filings with the Securities and Exchange Commission.

I'm pleased to report that UniFirst's third quarter of fiscal 2019 produced strong results for both our Company and our shareholders. Overall, revenues were up, setting a new record high for the Company at $453.7 million, an increase of 6.2% when compared to the same period last year. As for profits, operating income was $60.2 million, sharply higher than the $47.1 million a year ago and fully diluted earnings per share came in at $2.46 per share compared to $1.85 reported for last year's third quarter.

Both revenue and profit results for the third quarter came in ahead of expectations. Many expense items trended favorably in the quarter, contributing to our stronger than expected results. However, I want to express caution that although these quarterly results should be viewed positively, we do not believe they are necessarily indicative of a sustained trend of profitability at this level.

Certain variable costs such as health care as well as other items cannot be expected to continue at the same levels as our most recent quarter. I'd also like to note that overall payroll expense moderated in the third quarter partially due to continued market challenges being experienced related to recruiting and staffing. We continue to strategically plan and work through these issues as we move forward with the goal of increasing our headcounts to what we consider optimal levels that will maximize our efficiencies and our service levels to our customer.

And although we fully expect this additional staffing to positively contribute to ongoing Company growth and profits, it will also likely cause some short-term variability in our margins. Despite these challenges and our caution moving forward, we are pleased with the Company's overall performance in the quarter, a quarter where each of our operating segments exceeded expectations.

That said, I'd like to send sincere gratitude for our Executive -- from our Executive team and give credit to those folks who allow UniFirst to achieve our strong growth in the third quarter, our 14,000 plus employee team partners throughout North America, Central America and Europe.

Through the first nine months of the year, we continue to be encouraged by the solid performance of our sales organization, the primary driver of our organic growth. Our sales group continues to be on pace to exceed last year's record levels for new account sales. Likewise, I'm happy to report that UniFirst's customer retention continue to trend marginally positive when compared to the same time a year ago.

So as we look to the remainder of 2019 and ahead into fiscal year 2020, our primary focus remains the same. We continue to make smart investments in our people, our service infrastructure and our technologies company-wide, in order to achieve our long-term strategic corporate objective to be universally recognized as the best service provider in the industry.

And as discussed during our last earnings call, our strong balance sheet and healthy cash flow position continues to allow for any competitive business acquisitions that may make sense, for further investments in our Company and our team partners and for considering other capital deployment opportunities, all designed to ultimately deliver additional value to our shareholders.

And with that, I'd like to turn the call over to Shane, who'll provide additional details on our quarterly results and our outlook for the remainder of fiscal 2019.

[Shane O'Connor, SVP & CFO]

Thanks, Steve. Revenues in our third quarter of 2019 were $453.7 million, up 6.2% from $427.4 million a year ago. Operating income increased to $60.2 million from $47.1 million in the prior-year period or 27.9% and net income for the quarter increased to $47.2 million or $2.46 per diluted share from $36.4 million or $1.85 per diluted share.

Our Core Laundry Operations, which make up close to 90% of UniFirst's total business, reported revenues for the quarter of $399.8 million, up 5.5% from the third quarter of 2018. Core Laundry organic growth which adjusts for the estimated effective acquisitions as well as the impact of a weaker Canadian dollar was 5.8%.

During the quarter, our organic growth continued to benefit from solid new account sales, slightly improved customer retention, as well as the impact of certain pricing adjustments. Core Laundry operating income was $53.4 million for the quarter, up from $40 million in the prior year and the segment's operating margin increased to 13.4% compared to 10.5% a year ago.

This increase was partially due to larger than anticipated benefits from lower health care claims, lower production payroll as a percentage of revenues, as well as the capitalization of sales commissioning cost due to the adoption of new revenue accounting guidance in our first quarter of fiscal 2019.

In addition, several other operating and administrative expenses trended favorably and were positive contributors to the margin improvement. These items were partially offset by higher merchandise amortization as a percentage of revenues, although, we are cautiously optimistic as our merchandise costs have started to moderate compared to our previous expectations.

Energy costs decreased to 4.2% of revenues in the third quarter of 2019, down from 4.4% a year ago. During our quarter, the segment's operating income benefited from the capitalization of internal labor costs for our ongoing CRM projects. In addition, the quarterly comparison benefited from higher non-capitalizable consulting costs we incurred in the third quarter of fiscal 2018, primarily related to the evaluation of our CRM go-forward alternatives during that time.

Revenues from our Specialty Garments segment, which deliver specialized nuclear decontamination and clean room products and services, increased 9.6% to $37.3 million in the third quarter. This increase was primarily due to the benefit of acquisitions in fiscal 2018, which increased quarterly revenues by 7.6%. The segment's operating margin decreased to 14.4% or $5.4 million from 16.4% or $5.6 million in the year ago period.

This decrease was primarily due to higher costs related to its 2018 acquisitions, as well as higher merchandise amortization as a percentage of revenues. As we have 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 reported revenues increased by 16.6% to $16.6 million and its operating income decreased by 8.1% to $1.4 million. These fluctuations are primarily due to the Company's initiative to expand its first aid band business into new geographies and the related investments to support the expanded infrastructure.

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 $349.4 million at the end of our third quarter of fiscal 2019. Cash provided by operating activities for the first nine months of the year was a $199.4 million, an increase of $32.1 million from the first nine months of the prior year.

This increase was primarily due to cash received of $13 million in our second quarter of fiscal 2019 from a settlement agreement with the lead contractor for the former version of the CRM system, with respect to which we recorded a $55.8 million impairment charge in fiscal 2017.

Also contributing to the increase were lower working capital needs for the business, as well as a $3 million or -- as well as $3 million received from the settlement of environmental litigation in the first quarter of fiscal 2019. This increase was partially offset by the one-time bonus paid to our employees during the first quarter of fiscal 2019.

For the first nine months of fiscal 2019, capital expenditures totaled $88.2 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 objective.

During the quarter, we capitalized $1.9 million related to our new CRM project, which consisted of both third-party consulting costs and capitalized internal labor costs. As of the end of our third fiscal quarter, we had capitalized $7.9 million related to the CRM project, of which $2.9 million was related to internal labor capitalized in fiscal 2019. We continue to expect that our full-year capital expenditures will approximate $115 million.

During the third quarter of fiscal 2019, we repurchased 99,500 common shares at an average share price of $147.47 for a total of $14.7 million, under our previously announced stock repurchase program. As of May 25th, 2019, the Company had repurchased a total of 144,500 common shares at an average price of $145.01 for $21 million under the program.

Although our acquisition activity in the first nine months of fiscal 2019 was nominal, we continue to look for and aggressively pursue additional targets as acquisitions remain an integral part of our overall growth strategy.

I'd like to take this opportunity to provide an update on our outlook for fiscal 2019. We now expect that our fiscal 2019 revenues will be between $1.802 billion and $1.809 billion. During the quarter, both our operating income and net income exceeded our expectations.

Based on these better than expected results, as well as an improved forecast for our fourth fiscal quarter of 2019, we now expect our full year diluted earnings per share will be between $8.75 and $8.85. This guidance assumes our fourth quarter organic growth in our Core Laundry Operations will be approximately 3%, which is down sequentially due to the impact of the timing of certain pricing adjustment, as well as an operating margin at the midpoint of the range of 10.3%.

As Steve mentioned earlier, our third quarter results were impacted by several items that did not provide -- that may not provide the same benefit going forward, including health care costs as well as lower payroll expense, due in some part to under-staffing. Our guidance does not assume a comparable benefit in our fourth quarter from favorable healthcare claims experience, because these costs are unpredictable and can be highly variable from period to period.

In addition, the guidance also assumes improvement in our current staffing levels and normalization of some of our other operating and administrative expenses that provided benefit in our third fiscal quarter. As a reminder, our guidance for fiscal 2019 includes one extra week of operations compared to fiscal 2018, 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]

[Operator Instructions] And our first question comes from the line of Andrew Wittmann with Robert W. Baird. Please proceed.

[Andrew Wittmann, Robert W. Baird]

Great, good morning, guys.

[Steven Sintros, President & CEO]

Good morning.

[Andrew Wittmann, Robert W. Baird]

I guess my first question is a little bit devil's advocate and also there is some underlying truth to this question too, which is -- I mean the margins are obviously really good here, much better than you expected, we expected, everybody expected, and that's good. Growth was good. And I think a lot of folks look at your stock and believe that the margins have had a room for upside, you know based on history, based on peers, whatever.

So, we heard you loud and clear that you were understaffed here, Steve, and that that was kind of unsustainable. But can you just talk about that a little bit more and say like why is that unsustainable? Help us get comfortable that those investments really need to be made, given the strength of the quarter and the fact that your business is trending positively in lots of facets here today?

[Steven Sintros, President & CEO]

Sure. You know, couple of things and the under-staffing comment I think is valid for sure, but I don't want to put too much weight on it either. I think that's one of the things in the quarter. Based on the variability and I think volatility in the employment market, there is a little more ups and down in staffing levels we've seen over the last couple of years and quarter-to-quarter can provide you some temporary headwinds or benefits.

And so I think the comment was given in that regard. I think from the perspective of getting to where we feel we need to get to longer-term on growth rates, customer service levels to sustain better retention rates and so on, we feel there is a level of staffing and stability in the staffing that is optimal, that we're shooting towards, primarily on the service side and somewhat on the production side.

So the comments were made a little bit more in that regard. I think there is investments that we still feel need to be made in some of those areas to what we would consider, optimize those functions. But like I said, we're pleased with some of the trends in the quarter, but from a competitive perspective and from a long-term capabilities perspective, we do have a roadmap that we're looking at in terms of where we want to go with these different capabilities.

So that's why we're trying not to have one quarter's results sort of be viewed as everything's optimized at this point and these investments don't be -- don't need to be made, but I understand -- I understand the question, and we're balancing that as we go.

[Andrew Wittmann, Robert W. Baird]

Okay. I want to drill in a little bit more on the margins, because I think it's important. A couple of weeks ago at our conference, I think I asked you, if you could more confidently say that the margins had kind of bottomed this year, you know these quarters and -- are seeing, but do you expect that the margins had bottomed, can you say now after this quarter even recognizing that some of these things aren't maybe as sustainable as we'd all hope they would be.

Can you more confidently say now that you feel like the margin bottom is in place from here and that together with the top line leverage that you might be getting here that you feel like the margins can start to expand as we move into fiscal 2020 and beyond.

[Steven Sintros, President & CEO]

I think, Andy, we probably really don't want to get into that much forward-looking at this point, partially because I think we know that next year as we move closer to what will be preparing forward deployment of our technology system, there is going to be some costs that are incurred along the way there that could impact that statement, and that's kind of what we're working through and expect to have more communication as we go into year-end.

I think in terms of -- as we went through this year, some of the caution was around a couple of different areas. One being merchandise and that sort of was always the wildcard in terms of what were the trends that are going to sustain in terms of merchandise investments into the customer base and we're seeing that or have seen that during the quarter, moderate some. And that is encouraging, because I think that is an area that can swing the margins a point here or point there over time.

So again I'll go back to what we said, we're encouraged by the trend, but there is still investments to be made and I think next year we'll come together as we plan for the timing of the technology release and those other costs. And I do think that we have investments to make in the labor force as well to get to that optimal place where we feel like the teams are in place to provide the level of service that will lead to those sustainable growth rates as we move forward.

[Andrew Wittmann, Robert W. Baird]

Okay. And I guess I'm going to finish up with this one, I might jump back in queue later. But Shane, wanted to just try to get granular on some of these things, because they were significant. If you could help us understand the year-over-year benefit from the bigger buckets here? I heard health care, production, merchandise and sales commissions in the past, many of those you've helped to actually quantify, would you be willing to do that and able to do that again here today?

[Shane O'Connor, SVP & CFO]

Yeah, I can speak to some of the larger buckets, just coming off of last quarter. Some of these areas, it started to trend favorably in our -- in line with sort of our original expectations, and as you can see from our operating results, we continue to trend favorably -- or compared to what we originally expected.

I mean, Steve had mentioned the fact that production and service payroll trended favorably in some part due to under staffing. During the quarter, we actually received the benefit compared to prior-year comparable quarter of about 20 basis points to 30 basis points. And obviously sequentially, that's the improved off of last quarter where it was a headwind.

Our merchandise expense also started to moderate and also benefited from the strong organic growth during the quarter. That provided about 50 basis points of headwind, but that has improved compared to our original expectation. The selling payroll, which is strongly influenced by the capitalization of the commissions, it was about 70 basis points to 80 basis points of benefit year-over-year.

Healthcare claims also came in very, very strong -- a strong benefit for the quarter also, that was about 70 basis points to 80 basis points of benefit. And then I mentioned earlier that energy was about 20 basis points. In an above that, there were just a number of areas that trended favorably that make up the delta between our operating margin performance year-over-year. And in a lot of cases, those areas are subject to timing and we believe that this just turned out to be a low expense quarter.

In some cases, we're anticipating that some of those costs that we benefited from in the third quarter are actually going to roll over to the fourth and in other areas where our expectation is that they will normalize back to more of a historical level, but those are the macro items that sort of benefited the quarter.

[Steven Sintros, President & CEO]

And just to add to that, I think Andy, Shane mentioned a strong revenue growth during the quarter and our expectations are that the fourth quarter, the organic growth will take a step back, largely due to the timing of some pricing adjustments between this year and last year, and so those are causing some things that were a benefit this quarter, may not be quite the same benefit, from a margin perspective, on a year-over-year comparison next quarter.

[Andrew Wittmann, Robert W. Baird]

All very helpful answers, thank you. You might hear from me later, but I'll yield the floor for now.

[Steven Sintros, President & CEO]

Thank you.

[Operator]

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

[Tim Mulrooney, William Blair]

Yeah, good morning. Organic growth of 5.8%, obviously a very strong quarter for you guys. Is there anything to call out here in terms of specific customers or end-markets where you've seen particular pockets of strength or would you characterize the strength as being pretty broad-based?

[Steven Sintros, President & CEO]

I would say it's pretty broad based. I made the comment on the continued strength of our sales organization, coming off a strong sales year last year. We've continued to sell more new business this year. I think in the quarter, we sold -- or at least year-to-date, about 5% more than last year's strong year.

From a geographic perspective or end-market perspective, I'd say it has been pretty broad, I mean we're seeing some strength in the energy sector in West Texas, but that's a little bit isolated. It's not as broad, certainly is the last energy cycle.

And from a retention perspective, just broadly, we're a little bit better than the prior year. Shane mentioned the timing of the pricing adjustments that helped the quarter and proportionally won't help next quarters as much. But overall, I think we see a pretty healthy environment and one that's allowed us to be -- show decent growth rates.

[Tim Mulrooney, William Blair]

Yeah. No, absolutely. Did you guys quantify those pricing adjustments, Steve?

[Steven Sintros, President & CEO]

No. We typically don't break down those components of growth and I've always said before that part of the reason we don't is, quantifying those price adjustments are tricky because you'd have to really take into effect the pricing of new accounts versus the pricing of accounts you lost and it sort of can skew the relative impact of price overall. So we don't break all that out.

[Tim Mulrooney, William Blair]

Yeah. No, that's fair. One more from me, did weather impact you guys at all in the third quarter? I mean, I know it wasn't a major factor for you last quarter, but talking to a lot of services companies, this is a common theme that we're hearing. With all the rain and flooding in the Midwest, I'm curious if you felt any impact there?

[Steven Sintros, President & CEO]

Not particularly I think we -- may be based on our geographic presence, not being as strong in some of those parts of the country, we really didn't have any real headwinds there.

[Tim Mulrooney, William Blair]

Okay, great. Thank you. Congrats on a nice quarter.

[Operator]

[Operator Instructions] The next question comes from line of Judah Sokel with JPMorgan. Please proceed.

[Judah Sokel, JPMorgan]

Hi, good morning, how are you?

[Steven Sintros, President & CEO]

Good morning.

[Judah Sokel, JPMorgan]

First question is just a quick housekeeping question. The 3% organic guidance for core rental, does that adjust for the extra week to make it a same-day basis?

[Steven Sintros, President & CEO]

It does, it does.

[Judah Sokel, JPMorgan]

Okay.

[Steven Sintros, President & CEO]

We [indiscernible] the impact of the extra week, which will have about a 7.5% impact on the growth rate in that quarter.

[Judah Sokel, JPMorgan]

Okay, perfect. And then my second question is more of a high-level industry question. After two large mergers in the uniform services sector over the past couple of years, as well as some other mid-size, large-scale mergers, do you think there will be more scaled mergers in the industry prospectively? And do you expect UniFirst to play a role in any potential activity? Thank you.

[Steven Sintros, President & CEO]

Sure, Judah. I mean it's a good question. I think you know there is, not the larger players that they used to be, as you alluded to, there is still some good regional players out there that certainly we would like to participate in further consolidation with.

As far as consolidation at the top of the industry, your guess is as good as mine. I think it remains to be seen how that shakes out over the next five plus years. But right now we're sort of focused on ourselves in that regard and feel good about our opportunity to be a strong player in the marketplace. And like Shane said, we'll look at opportunities on acquisitions as they come available in due course.

[Judah Sokel, JPMorgan]

Makes sense, thank you, guys.

[Steven Sintros, President & CEO]

Thank you.

[Operator]

[Operator Instructions] And we do have a follow-up question from Andrew Wittmann with Robert W. Baird. Please proceed.

[Andrew Wittmann, Robert W. Baird]

Yeah. Great, so as to the last question, you said you have more information later, Steve, Shane both of you on the CRM. Just can you give us an update on that progress? How well implemented are you? And any updated timing on when that might go live?

[Steven Sintros, President & CEO]

I think that the comments that we'll make about the CRM at this point in time is, from our perspective, the project is going very, very well and we're very optimistic about the progress that we'd made. We also are very pleased with the partnership and the company that we partnered with, as we implement the changes to the system, as we move farther along our implementation

As it relates to the timeline, I think that we'll still defer those comments to the end of our fiscal year and the comments we make in a few months, where we'll give you an update on our next fiscal year as well as additional information on the timing of that project.

[Andrew Wittmann, Robert W. Baird]

Great. And then I just -- guess my last question has to do with kind of the macro environment a little bit more and specific around add stops, I was hoping you could comment on that. If you look at the labor data, we've got this low unemployment rate, but jobs last month in terms of net adds kind of missed, kind of tells me that there is an increasing shortage of labor in the markets, but that's just one view of it.

Steve, I think maybe if you could talk about how -- what you're seeing from your customer behavior about their ability to add employees, if it's a labor shortage in terms of not being able to find people, if it's business demand levels that's driving their behavior. Just some thoughts around the operating environment there, I think would be helpful.

[Steven Sintros, President & CEO]

Sure. I think our situation is sort of symptomatic of our customers as well. And where there is -- there is a labor shortage, for sure. In our add reductions number, I didn't mention this, but we're a little bit incrementally worse than the prior year, not big enough to make a major move on the growth rates.

But I think we are hearing from customers consistent, what we're seeing with ourselves which is that there is just, in many, many markets there is a supply-demand issue in terms of labor availability. We have really not heard that the lack of hiring broadly relates more to business softness, but more to difficulty finding labor. So I think that's a...

[Andrew Wittmann, Robert W. Baird]

You said -- Sorry, go ahead. No, please go ahead.

[Steven Sintros, President & CEO]

No, I was -- I was pretty much completed.

[Andrew Wittmann, Robert W. Baird]

Okay, so you said that add-stops are a little weaker year-over-year, but there is still positive?

[Steven Sintros, President & CEO]

No, I think we've talked about this before, and I think it gets into, we don't get into the nitty-gritty with some of these operating metrics, our adds reductions on the garment side tend to run negative fairly consistently. I think partially based on maybe the way we track certain things between new sales and adds reductions, but they're just incrementally worse. I mean, they are sort of -- they're not dramatically negative but they are somewhat negative and have been and typically are on a consistent basis.

[Andrew Wittmann, Robert W. Baird]

Okay, all right. That's it from me. Thank you.

[Steven Sintros, President & CEO]

Thank you.

[Operator]

And there are no further questions on the telephone lines.

[Steven Sintros, President & CEO]

Okay, great. I'd like to thank everyone for joining us today to review our third quarter results. We look forward to speaking with you again in October, when we expect to report our fourth quarter and full year performance, as well as our expectations for fiscal 2020. Thank you and have a great summer.

[Operator]

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