UniFirst Corp (UNF) Q2 2021 Earnings Call Transcript

UniFirst Corp (NYSE: UNF) Q2 2021 earnings call dated Mar. 31, 2021.

Corporate Participants:

Steven S. Sintros — President and Chief Executive Officer

Shane F. O’Connor — Senior Vice President & Chief Financial Officer

Analysts:

Andrew Wittmann — R.W. Baird — Analyst

Andrew Steinerman — JPMorgan — Analyst

John Cummings — Copeland Capital — Analyst

Presentation:

Operator

Greetings and welcome to the UniFirst Corporation Second Quarter Earnings Conference Call. [Operator Instructions]

It is now my pleasure 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’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 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 are 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 account sales have been solid during the first six 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’ve 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 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 F. O’Connor — Senior Vice President & Chief Financial Officer

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 efficiencies associated with the 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 effective 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. However, during the quarter, our top line performance was impacted by approximately $2 million 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 healthcare 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 continued 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 have 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 US 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 at 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 Issues] for our new capabilities like mobile handheld devices for our route drivers will ramp to an estimated $6 million 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 $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 healthcare 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.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Andrew Wittmann of Baird. Please go ahead.

Andrew Wittmann — R.W. Baird — Analyst

Yeah. Thanks for taking my question, guys. And good morning.

Steven S. Sintros — President and Chief Executive Officer

Sure. Good morning.

Andrew Wittmann — R.W. Baird — Analyst

I guess I wanted to just talk a little bit — I wanted to talk a little bit on the top line trends. I heard you guys say in the quarter, no headwinds, no tailwinds, kind of stable performance. March is 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 pick up over the February levels? 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 S. Sintros — President and Chief Executive Officer

Sure, Andy. I think — maybe I would characterize March as a slight pickup from February. Now, seasonally typically coming out of the winter months, we have — we have said 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, they’re 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 were 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 — Analyst

Are there any leading indicators that you have — or what are those leading indicators that you’re looking at to give you some confidence? I mean, the second half revenue guidance obviously comes against an easier compare, and that’s probably the 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 aren’t baked in or maybe some of the areas of risk. If you could just kind of talk about some of those factors, that’d be helpful.

Steven S. Sintros — President and Chief Executive Officer

Yeah. When we look at our revenue trends, I guess compared to three 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. When you look at our growth metrics, I talked about new account sales; we’re seeing a little bit better momentum there as we look toward 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-forward 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 — Analyst

Great. That’s really helpful. I wanted to ask one other on one other topic here. And actually it turns out that you 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 are — I guess 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 some costs, $2.2 million on the CRM in the quarter. I think I also heard that, say, 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, but that would be helpful. Thank you.

Shane F. O’Connor — Senior Vice President & Chief Financial Officer

Yeah, yeah, yeah. And thanks for pointing that out, Andy, and I apologize for the technical difficulty. Just to make sure we’re all clear, during the quarter we capitalized an additional $2.2 million related to the CRM project. At this point in time, we’re at the end of our quarter, we had 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 with an estimated useful life of about 10 years. So in the second half of the year, our expectation is that we’ll 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’ll 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 — Analyst

Okay. That’s helpful. Then let’s just drill in on that. If the second half of this year is $5 million of things like that, I guess that means on an annualized basis, that’s $10 million. So as we think about fiscal ’22, you’ve got I guess another $5 million assuming kind of the rates of these things increases or decreases. Is that the right way to think about how that layers into your fiscal ’22 numbers? And given that the system is really supposed to be getting rolled out into ’23 like you said early 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 F. O’Connor — Senior Vice President & Chief Financial Officer

Yeah, 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 the way you’re thinking about it is appropriate.

Steven S. Sintros — President and Chief Executive Officer

And just to be clear, Andy, when we talk 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 teams deploying, it’s the IT team continuing to support through deployment, that could be in the $10 million range on an 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 — Analyst

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

Steven S. Sintros — President and Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Our next question comes from Andrew Steinerman of JPMorgan. Please go ahead.

Andrew Steinerman — JPMorgan — Analyst

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 the year-over-year comps and we haven’t seen recovery yet. It’s 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 but towards merchandise amortization?

Steven S. Sintros — President and Chief Executive Officer

Okay. Very thorough, multipart 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 and such. You’re also correct that March — March — we started to see declines last year in the second half of March. So 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 on the second part of the question. Oh, I think you’re talking about…

Andrew Steinerman — JPMorgan — Analyst

Any end market comments that are not related to energy.

Steven S. Sintros — President and Chief Executive Officer

Yeah. So, in general, I think we’ve talked a little bit about — there are places where we’re seeing improved activity even in no programmers with dentists’ office and some other sort of healthcare applications that have become a larger part of our end market offerings during COVID in particular. So certainly there is some strength there. I think you — we aren’t as heavy in food, in beverage and hospitality. I think you are seeing improvements in that sector. But they’re not providing us a tremendous pull 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 — 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 pull. 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 F. O’Connor — Senior Vice President & Chief Financial Officer

Yeah. So when we take a look at the margins, not only for the second half of the year but broadly there with 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 different.

As we look towards the second half of the year, we can — or we expect that 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. Clearly, during this we have learned that there are very, very capable tools available to us that allow us to work with people face to face, whether it’d be Microsoft Teams or Zoom that we will be utilizing and we probably will have more of a permanent benefit as it relates to our travel expenses. That being said, they will — they will ramp from where they are currently.

From a healthcare perspective, we sort of called it out in my prepared remarks. This quarter, our healthcare claims cost was high. 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 have been receiving, where a lot of discretionary surgeries and other doctors’ 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 healthcare claims costs we are experiencing. Throughout the remainder of the year — our second quarter experience has informed some of our forecast 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 have 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 amortized those over in 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 expect that 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.

Steven S. Sintros — President and Chief Executive Officer

One of the thing I would add, Andrew, is on energy. I don’t know 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 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 pickup as well.

Andrew Steinerman — JPMorgan — Analyst

Got it. Okay. Thank you.

Operator

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

John Cummings — Copeland Capital — Analyst

Hi, good morning. Thanks for taking the question. I wanted to get an update on your dividend — your dividend philosophy and just trying to understand if you plan on increasing or evaluating the dividend on an annual basis. And then also if there’s any general comments you can make in terms of the target payout ratio or goal with the dividend?

Steven S. Sintros — President and Chief Executive Officer

Yeah, 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 over the last year with the pandemic, it’s been a bumpy year. But it will be something as things smooth out that we will continue to look at. We don’t have a formal communicated policy in place right now, but it is something you can — you can count on us looking at it on an annual basis and evaluating.

John Cummings — Copeland Capital — Analyst

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

Steven S. Sintros — President and Chief Executive Officer

We 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 — Analyst

Thank you.

Steven S. Sintros — President and Chief Executive Officer

Thank you.

Operator

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

Steven S. 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

[Operator Closing Remarks]