UniFirst Corporation (UNF) Q2 2022 Earnings Call Transcript

UniFirst Corporation  (NYSE: UNF) Q2 2022 earnings call dated Mar. 30, 2022

Corporate Participants:

Steven S. Sintros — President and Chief Executive Officer

Shane F. O’Connor — Executive Vice President and Chief Financial Officer

Analysts:

Andrew Wittmann — R.W. Baird — Analyst

Sam — William Blair — Analyst

Andrew Steinerman — J.P. Morgan — Analyst

Presentation:

Operator

Greetings and welcome to the UniFirst Corporation Second Quarter’s Earnings Conference 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,, President and Chief Executive Officer. Please go ahead.

Steven S. Sintros — President and Chief Executive Officer

Thank you and good morning. I’m Steven Sintros, UniFirst 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 UniFirst Corporation’s conference call to review our second quarter results for fiscal year 2022. 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 Form 10-K and 10-Q filings with the Securities and Exchange Commission.

During the quarter, as always, our team continue to focus on providing industry-leading service to our customers, as well as selling prospective customers on the value that UniFirst can bring to their businesses. I want to thank our thousands of team partners, who in the face of a challenging operating environment, continue to always deliver for each other and our customers. Overall, our second quarter results reflect a strong top line performance with consolidated revenues growing 8.2%.

The teams continues to execute well, producing solid performances in both new account sales, as well as customer retention so far this year. In addition, [Indecipherable] additions versus reductions year-to-date are positive, indicating the continued growth and recovery of our customer base. The strong year-over-year growth in the quarter was also impacted by adjustments to customer pricing as we continue to work with our customers through this inflationary environment.

As a reminder, we discussed during our year-end earnings call that going forward over the next few years, we’re going to be focused on three discrete strategic initiatives that are critical in our efforts to transform the company in terms of our overall capabilities and competitive positioning. These initiatives are the rollout of our new CRM system, investments in the UniFirst brand and a corporate wide ERP system with a strong focus on supply chain and procurement automation and technology.

As we have talked about over the last year or two, we continue to be focused on making good investments in our people, our infrastructure and our technologies. All of our investments are designed to deliver solid long-term returns for UniFirst stakeholders and are integral components of our primary long-term objective to be universally recognized as the best service provider in our industry. We continue to report adjusted results for the direct impact related to these investments.

Speaking of these key initiatives, we are excited to report that during March, we officially launched our new brand through a series of ads in the NCAA March Madness Tournament featuring real UniFirst customers and employees. We are very excited to rally our company around our new master brand message, a message that focuses on serving people who always deliver for their companies, their customers and their families. At UniFirst. Our focus will continue to be to always deliver for them. What makes this message exciting for us is we feel it is genuine to our culture and purpose as it was developed through extensive research and feedback from our employees and customers. We are very much looking forward to delivering on this promise.

With respect to our CRM systems project, we continue to make good progress, deploying our new system in line with our internal schedule. Assuming we progress as expected, we will have approximately half of our core laundry locations on the new system by the end of fiscal 2022. After excluding the impact of costs that we are spending on our key initiatives, our diluted earnings per share for the quarter was $1.24. Although our core laundry operating margin was somewhat lower than our internal expectations, the quarter played out mostly as expected.

As a reminder, our second quarter is seasonally our lowest margin quarter due to the impact of the holidays, as well as the timing of other certain costs. The shortfall in margin compared to our expectations was largely due to the continued impact from the inflationary environment, as well as somewhat improved staffing levels as we continue to work through the challenging labor environment. We do expect that increase in cost of labor, raw materials and energy will continue to have a direct impact on our results as well as translate into higher cost from our vendor partners who are experiencing similar challenges.

As I mentioned, we have and will continue to work with our customers to appropriately sharing these cost increases, as well as work to mitigate them through operational efficiencies. Despite the challenges in the overall operating environment, we continue to be confident in our ability to manage and execute through these obstacles. We maintain a sharp focus of taking care of our employees, our customers and bringing new customers into the UniFirst family.

And with that, I would like to turn the call over to Shane, who will provide the details of the results of our second quarter and our outlook for the remainder of fiscal ’22.

Shane F. O’Connor — Executive Vice President and Chief Financial Officer

Thanks, Steve. In our second quarter of 2022, consolidated revenues were $486.7 million, up 8.2% from $449.8 million a year ago and consolidated operating income decreased to $22.6 million from $40.7 million. Net income for the quarter decreased to $18.5 million or $0.97 per diluted share from $32.6 million or $1.71 per diluted share.

Our financial results in the second quarter of fiscal 2022 included $6.7 million of cost directly attributable to the three key initiatives that Steve discussed. Excluding these initiative costs, adjusted operating income was $29.4 million, adjusted net income was $23.5 million and adjusted diluted earnings per share was $1.24. Although our financial results in the prior year may have included direct costs related to these key initiatives, which in our second quarter of 2021 would have primarily been for our CRM initiative, company did not specifically track the amounts that were being expensed. This was because the amount was less significant in value and a large number of the costs were still being capitalized. As a result, we will not be providing adjusted amounts for the prior-year comparable period.

Our core laundry operations revenues for the quarter were $433.1 million, up 8.7% from the second quarter of 2021. Core laundry organic growth, which adjusts for the estimated effective acquisitions, as well as fluctuations in the Canadian dollar was 8%. This strong organic growth rate was primarily the result of customer reopenings in fiscal 2021, solid sales performance and improved customer retention, as well as efforts to share with our customers the cost increases that we are seeing in our business due to the current inflationary environment.

Core laundry operating margin decreased to 4.3% for the quarter or $18.7 million from 8.9% in prior year or $35.4 million. The costs we incurred during the quarter related to our key initiatives were recorded to the core laundry operations segment and excluding these costs the segments adjusted operating margin was 5.9%. The decrease from prior year’s operating margin was primarily due to higher merchandise amortization, which continues to normalize from depressed levels during the pandemic, as well as the effect of large national account installations, which are providing additional merchandise amortization headwind.

During the quarter, the adjusted operating margin was also impacted by higher travel and energy costs as a percentage of revenues, as well as wage inflation we continue to experience responding to the very challenging employment environment. Energy costs increased to 4.7% of revenues in the second quarter of 2022, up 4.2% in the prior year.

Revenues from our Specialty Garments segment, which deliver specialized nuclear decontamination and cleanroom products and services, increased to $35.5 million from $35.2 million in prior year or 0.9%. This increase was primarily due to growth in our cleanroom and European nuclear operations, which was partially offset by higher direct sale activity in the prior year. Segment’s operating margin decreased to 10.8% from 14.9%, primarily due to higher gross margin on its prior year direct sales, as well as higher labor costs as a percentage of revenues. 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 segment’s revenues increased to $18.1 million from $16.3 million in the prior year or 11%, primarily due to strong growth in the First Aid van business. However, the segment’s operating income was nominal during the quarter, primarily due to 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 $425.9 million at the end of our second quarter of fiscal 2022. In the first half of 2022, cash provided by operating activities was impacted by our reduced profitability, including the impact of initiative costs, as well as heavier than normal working capital needs of the business. Contributing to these higher working capital needs or elevated accounts receivable balances, as well as supply inventory, primarily due to ongoing supply chain disruption.

In addition, rental merchandise and service has increased as our balance sheet position continues to normalize coming out of the pandemic impacted period. In 2022, we also paid an additional $12.2 million in FICA payments that we were able to defer from prior years as part of the CARES Act. For the first half of fiscal 2022, we continue to invest in our future with capital expenditures totaling $60.2 million and the acquisition of eight businesses for which we paid $42.3 million. During the second quarter of fiscal 2022, we also purchased 52,500 common shares for a total of $10 million under our previously announced stock repurchase program.

I’d like to take this opportunity to provide an update on our outlook. At this time, we now expect that full year revenues for fiscal 2022 will between $1.967 billion and $1.980 billion. We further expect that our diluted earnings per share for fiscal 2022 will will now be between $5.62 and $5.82. This earnings per share guidance assumes an effective tax rate of 24% and includes a revised estimate of $30 million worth of costs directly attributable to our key initiatives that will be expensed during the year.

Please also note the following assumptions regarding our fiscal 2022 guidance. Core Laundry operations adjusted operating margin at the midpoint of the range is now 8.6% and implies an adjusted operating margin over the second half of our fiscal year of 9.4%. This revised outlook reflects continued pressure from the current inflationary environment including the recent surge in energy prices. Our adjusted tax rate for fiscal 2022 is 24.2%. The adjusted diluted earnings per share is expected to be between $6.80 and $7. Guidance does not include the impact of any future share buybacks or potential tax reform and guidance assumes a stable economic environment with no pandemic related headwinds.

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

Operator

[Operator Instructions] Our first question comes from Andrew Wittmann with Baird. You may proceed with your question.

Andrew Wittmann — R.W. Baird — Analyst

Great. Good morning, guys and thanks for taking my question. I guess, Steve, I wanted to ask about the profit margins from the perspective of the merchandise costs. And it seems like the way you talked about it that this was probably the largest bucket, maybe you can talk about that specifically in your answer, but I guess how do you — how can you get us comfortable that the pricing that you’re realizing in the market is sufficient or is at a level where you’re able to get the profit margins that you want?

I understand that energy prices are volatile and those move around a lot and the labor market has changed a lot. But I feel like that the pricing you’re getting and that the amount of labor — merchandise costs that you feel like should be priced for in your quotes to your customers? And I just feel like the margins are a little bit softer than I would have expected even adjusted for the fuel and the labor prices out there? And I just wanted to hear your comments on how you’re able to price the business as there’s an increase in competition that might be driving some of that or just basically comment on all of that in its totality?

Steven S. Sintros — President and Chief Executive Officer

Sure. When you look at it, in particular, how you’re approaching the question in terms of merchandise and overall our ability to price in the market, I don’t think that’s how we should be viewing the higher merchandise cost impacting the quarter. I mean, certainly some of the cost bounce back that we’re experiencing in terms of things like merchandise compared to the prior year quarter is a result of the depressed level of merchandise or the reduced level of merchandise that was being input during some of the pandemic periods.

So that bounce back in merchandise is a year-over-year challenge. When you look at the cost of merchandise, there is a factor in there as well related to inflation, as well as the cost of raw materials, transportation and labor that are impacting merchandise as well. So, it’s really a two-fold impact on merchandise. I wouldn’t say the broader commentary around pricing — in terms of the environment we’ve talked before, it’s a competitive industry, It’s a competitive environment, I’m not sure that the dynamic has changed significantly over the last couple of years.

When you look at the margin shortfall, taking a step back over the last few years, there has been lots of dynamic — it’s been a dynamic environment as far as our results go, things helping and hurting our numbers during the pandemic. we talked during the pandemic about how lower merchandise, energy, travel and some other things were going to bounce back and that’s certainly happening. Now that’s also being exacerbated now by the inflationary environment, energy and so on.

And then as we’ve also talked about some of the margin headwinds relate to not only the initiative costs that we’ve specifically carved out, but some of the investments, I’ll say disruption around some of the projects we’re doing do have costs that are outside of the direct costs that we’re reconciling out. So, all of those things are contributing to the margin story, but like we talked about, I think the biggest delta between our expectations and what the results are, are some of those inflationary pressures around, not only labor and energy, but also the flow through impact that those are having on things like merchandise and other supplies and services. So, we continue to work with our customers from a pricing perspective and we’ll continue to do that to offset at the best that we can.

Andrew Wittmann — R.W. Baird — Analyst

Got it, okay. I just follow up on that, I guess, obviously energy prices are more unpredictable, but I guess could you comment on what you’re seeing in the labor market in terms of our things normalizing in terms of the rate of growth and wages? And can you talk about, and I know this is a hard question, but can you talk about when you believe that you’ll be on the better side or at least breakeven on the price cost dynamic for your margins? I know that’s a tricky one, but just wondering how you’re thinking about that today?

Steven S. Sintros — President and Chief Executive Officer

Yes. So I guess the first comment on labor, I would say that, I mentioned in my comments that we are a little bit better staff today than we were a few months ago. So that’s certainly positive. I would say it’s still a challenging environment in terms of we’re experiencing higher employee turn, which I don’t think is unique in this market from prior years, and so there’s sort of a cost associated with that as well. As far as normalizing, I would say that as we continue to experience the higher turnover, we have to continue to evaluate that sort of breakeven between turn and wages. So, I would say that the environment is improving, but I wouldn’t categorize it as wholly stable.

As part of your — second part of your question is to when that normalization occurs between sort of price and inflation in cost. We’re going to continue to work through some of these increases and what we can extract out of pricing in this environment and I think that there’s some positive trends that hopefully will occur over the upcoming quarters in that regard, meaning the pace of cost increases hopefully will slow and we can sort of grow into the new cost environment. So that’s obviously our goal and what we’re going to be working towards.

And I think there’s some signs of that. I think when you look at less pressure from COVID-related absences and so on, as well as some of the supply chain disruptions starting to ease a little bit, again, I want to hesitate to say we’re beyond all of those challenges, but I do see a time where we can start normalizing or flattening some of those increases and grow into the new cost structure.

Andrew Wittmann — R.W. Baird — Analyst

Great, thanks for those perspectives.

Steven S. Sintros — President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Sam [Phonetic] with William Blair. You may proceed with your question.

Sam — William Blair — Analyst

Hey, good morning and thanks for taking our questions here. I want to touch on labor again. Do you have a sense for how much of that step-up in your labor costs are really related to base wage rate increases versus say paying over time or turnover costs to cover the labor shortage issue?

Steven S. Sintros — President and Chief Executive Officer

Yeah, that’s an excellent question. It’s not something that we have a breakdown prepared for. I would say that when you look at the year-over-year increase in cost, it’s certainly both. I think the lion’s share of it is wage increases, but it is more difficult to assess the cost of turnover in a production environment where — or service environment where you have the impact of newer employees, training, not just the hard cost of training, but the soft cost of management distraction to be hiring more often, bringing people up to speed more often.

So, we don’t have a great numerical answer for that. I would still say that there is a heavy cost from the pure wages, certainly those other costs and that’s why I talked about the balance of continuing to find the right wage point where you’re optimizing the wage versus over time training and so on. So, it’s a complex way to approach it. But that’s what we’re trying to find the balance of.

Sam — William Blair — Analyst

No. I totally understand it’s a complex issue, but appreciate your characterization there. Maybe pivoting to customer utilization. We get the sense when talking to some of your smaller competitors that most customers have fully reopened at this point, but that the utilization rates are still well below pre-COVID norms. Is that how you would characterize the current state of the market as well? And if so, do you still have a sense of what your customer utilization rates are at relative to pre-COVID? Are we talking 70%, 80%, 90%, just any sense you give us on that issue?

Steven S. Sintros — President and Chief Executive Officer

Yeah, I would probably say that I feel like that number is on the higher side. I think depending on the industry I know from some of our experience and from talking to smaller competitors as well, certainly, the food and beverage arena is one where — although there is reopening, there is some less level of activity and some hospitality as well. We’re not over-weighted in some of those sectors. So, we are probably experiencing some of that, but the vast majority of what I would consider are more traditional industrial customers not in those sectors. I feel like we’re at pretty healthy levels right now compared to pre-pandemic.

Again you do hear pockets and I’ll make the comment in the energy sector that although we’re seeing some increased activity, we’ve heard commentary from customers in the energy sector and other sectors that there would be more hiring if they could find the people and more activity. So, I do think that the labor environment is causing some shortfall in activity, but I do feel like that a lot of our industrial accounts are pretty close to pre-pandemic levels.

Sam — William Blair — Analyst

Excellent. I appreciate the answer to the questions here.

Steven S. Sintros — President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Andrew Steinerman with J.P. Morgan. You may proceed with your question.

Andrew Steinerman — J.P. Morgan — Analyst

Hi, Steve, I was hoping you might be willing to quantify, kind of realize client pricing in the second quarter since it’s sort of so pivotal here, like for example is realized pricing in the second quarter above 2% and you’re going to have to remind me if you include or exclude or charge a fuel surcharge. I just forgot exactly how you do pricing? And then I’ll just give you my second question as well. Do you think you have better visibility on margins over the next two quarters than you did three months ago?

Steven S. Sintros — President and Chief Executive Officer

So to partially answer the first part of your question, I would hesitate to give an exact impact of pricing, it’s certainly dynamic in this environment. I would say we’ve been able to do a little bit more than normal for sure and this recent surge in energy prices will have us revisiting what we can do and maybe need to do. In terms of energy surcharges, we as well as I think most of our competitors or people in the industry have some component of the bill that roughly aligns with delivery costs and energy costs, but we continue to look at what we need to do given the dynamic nature of the environment.

With respect to the outlook over the next couple of quarters, Andrew, I would say that it’s a difficult question. I think when you look at the outlook, I would say that the commentary we made about inflationary impact in vendors sort of having to do things to try to balance their margins and their cost pressures, I think we still think the environment is somewhat dynamic when you look at staffing levels and whether it’s energy prices or other activity from vendors. I do think it’s still a pretty dynamic environment.

So, I wouldn’t necessarily consider it a better time to be projecting the numbers than a few months ago, but I will say that being said with the smoothing out of the environment from a COVID perspective, there was more disruption a few months ago when we were trying to give an outlook than there is now from that perspective.

Andrew Steinerman — J.P. Morgan — Analyst

Thank you. Yeah, that makes sense.

Steven S. Sintros — President and Chief Executive Officer

Thank you.

Operator

We have no further phone questions at this time, sir.

Steven S. Sintros — President and Chief Executive Officer

Well, I’d like to thank everyone for joining today to review our second quarter results. We look forward to speaking with you again in June when we expect to be reporting our third quarter performance, as well as our outlook for the remainder of the year. Thank you all and have a great day.

Operator

[Operator Closing Remarks]