UniFirst Corporation (UNF) Q2 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Second Quarter 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] It is now my pleasure to turn the conference over to Steve Sintros, Chief Financial Officer at UniFirst Corporation. Please go ahead sir.

Thank you, and welcome to the UniFirst Corporation conference call to review our second quarter results for fiscal 2015 and to discuss our expectations going forward. I'm Steven Sintros, UniFirst's Chief Financial Officer. Joining me is Ronald Croatti, UniFirst's President and Chief Executive Officer. This call will be on a listen-only mode until we complete our prepared remarks. Now before I turn the call over to Ron, I would like to give 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 our risk factors in our most recent 10-K and 10-Q filings with the Securities and Exchange Commission. Now, I will turn the call over to Ron Croatti for his comments.

Thank you, Steve, and welcome to everyone joining us for the snapshot of UniFirst's second quarter and year-to-date financial results for fiscal year 2015. I will be providing a brief review of our most recent performance and I’ll turn it back over to Steve for the details. I am very happy to report that UniFirst Corporation had another solid performance in the second quarter of fiscal 2015, continuing the positive revenue and net income trends of the recent quarters. Once again, I would like to thank our thousands of UniFirst Team Partners worldwide for their continued efforts and company commitment as we know they are the ones responsible for our ongoing success, our annual growth, and our ability to remain a true industry leader. Revenues for the second quarter were $361.5 million, improving 5.1% over the second quarter of 2014. Six month year-to-date revenues were $731.8 million, increasing 6% over last year’s mid-year mark. These were new revenue records for both the quarter and for the six month year-to-date. Net income for the quarter was $25.4 million compared to $25.6 million for the same period a year ago. Excluding the impact of the environmental liability charge we took during the quarter, net income grew 7.8% over 2014 second quarter. Meanwhile, net income for the first half of the year was 8.3% improvement over last year excluding the environmental charge. As has been the tradition, the growth was driven by our Core Laundry operations, which account for about 90% of UniFirst total revenue. Factors contributing to the growth include solid new account sales and a modest customer pricing improvement that aided our top line combined with continued advances in operational efficiencies, companywide moderate energy cost relief associated with lower oil prices that partly affect margins. These and other operational elements combined to result in new quarterly revenue and operating income records for our laundries. Our Specialty Garment segment, which is our specialized nuclear and clean room service unit, reported drop offs for the quarter in both revenue and operating income when compared to the same quarter in 2014. As for our First Aid and Safety segment, the unit reported another strong quarter of financial results and through the six months of the year reported revenues, operating income growth 10.4% and 69.8% respectively. Overall, we are pleased with UniFirst performance for the first six months of fiscal 2015. And looking ahead, we expect to achieve solid growth for the year, but we expect our recent growth rate trend to slow slightly due to several factors. First has to do with demand for protective uniforms and services in our oil drilling markets, particularly those in West Texas and surrounding areas as well as Edmonton, Alberta with the lower energy cost associated with the recent drops in oil pricing beneficial to consumers and lower prices also have a negative effect on uniform demand in our oilfield markets, markets that have been positively contributing to our margins in recent years. As we cautioned in our last webcast, we are now seeing significant losses in uniform wearers and customers associated with the dips in these niche markets. And the drop offs are not only coming from oil drilling businesses themselves and with ancillary businesses associated with them. We’ll continue to watch this situation very closely and strategize accordingly, and unfortunately we are not able to accurately forecast how far or how long these weekly losses may continue. The second challenge we expect to continue negatively impacting our growth rate is the weaker Canadian dollar exchange rate. Steve will elaborate more on this in just a moment. Thirdly, we expect to be further tested on slow growth in the national economy that continues to limit our new account sales and added uniform opportunities. Although national employment is making some gains in worker headcount, we are not yet seeing them translate into organic increases in uniform demand within our current customer base. And lastly as always, we expect to be challenged by competition on the sales side. So to corner these extreme factors and maintain growth for fiscal 2015 and beyond, we will continue to focus on our primary efforts on four main areas that we feel we can control. First, ensure we are providing the utmost and service excellence at all times in all markets at all UniFirst facilities, constantly delivering the highest quality products and services to our many thousands of business customers to maximize retention and business referrals. Second, look to our field and national account sales team to aggressively pursue and close more new accounts in a consultative manner to drive organic growth. It will supplement the growth with a business acquisition opportunity that may arise that are consistent with our long-term goals. Third, maintain tight cost control at all locations and operations to contain spending, but never to the point of affecting our ability to deliver the service excellence mandated I mentioned. And fourth, manage our company, our locations, our operations with a detailed growth framework laid out in our corporate listed 2020 business plan. On following these four basic business plans, we expect to continue our long track record and solid results in return for our shareholders, our customers, and our staff. Now, I’d like to turn it back over to Chief Financial Officer, Steven Sintros, for the details on the second quarter.

Thanks, Ron. Second quarter revenues, as Ron mentioned, were $361.5 million, up 5.1% from $344 million a year ago. Net income for the quarter was $25.4 million or $1.26 per diluted share compared to $25.6 million or $1.27 per diluted share reported in the second quarter of last year. As Ron mentioned, the current quarter’s results were impacted by a $3.6 million charge to selling and administrative expenses to increase the company’s reserves for environmental liabilities. Excluding the effect of this charge, net income would have been $27.7 million or $1.37 per diluted share, an increase of 7.8% from the prior year. This increase in environmental reserves was due primarily to additional cost the company expects to incur associated with the planned municipal project to build the transit station in the area of our Somerville, Mass environmental site. To a lesser extent, our reserves were also increased due to the effect of lower interest rates on the discounting of our environmental liabilities. Revenues in the Core Laundry operations for the second quarter were $332.1 million, up 6% from those reported in the prior year second quarter. Excluding the negative impact of the weaker Canadian dollar which was 0.8% as well as the positive contribution from acquisitions which was 0.7%, the Core Laundry operation revenues grew 6.1%. Revenues for the quarter were driven by several factors including strong new account sales not only for the quarter but for the last 12 months as well as annual price adjustments. Partially offsetting these positive growth drivers, lost accounts are running slightly higher than fiscal 2014 which was a strong year for customer retention. In addition, our revenues during the quarter began to be affected by decreases in NetWare accounts at our existing customers. As anticipated, these reductions are primarily at customers that are directly or indirectly support energy production, oil in particular. Excluding the environmental charge discussed earlier, the Core Laundry operating income during the quarter increased 12.9% and adjusted operating margins increased to 13.4% from 12.6% a year ago. The improved margin was primarily due to lower energy cost during the quarter, the result of lower fuel for our fleet of delivery vehicles. Energy cost for the Core Laundry operations were 4.6% during the quarter compared to 5.4% in the second quarter of 2014. As anticipated, merchandise amortization has started to trend higher in the quarter but was offset by lower payroll related costs and other miscellaneous decreases in cost of revenues. Revenues for the Specialty Garment segment for the second quarter which consist of our nuclear decontamination and clean room operations were $18.7 million, down 8.6% from $20.4 million in the second quarter of fiscal ’14. This segment incurred a loss from operations for the quarter of $0.4 million compared to income from operations of $0.3 million a year ago. Our fiscal second quarter has always been a weak quarter for this segment due to lack of power reactor outage work during the peak energy demand season of winter. Results during the current quarter were also negatively affected by the impact of fluctuations in foreign exchange rates of this segment on this segment’s European business as well as certain Canadian customers. Our First Aid segment produced another solid quarter of results with revenues increasing 3.4% and operating income up 9.5% compared to the second quarter of 2014. Current quarter profits were also impacted by foreign exchange rate losses of $0.9 million compared to $0.7 million a year ago. This increase was due to the weakening of the Canadian dollar and Euro against the U.S. dollar during the quarter. UniFirst continues to maintain a solid balance sheet and financial position. Cash provided by operating activities during the first half of the year was $107 million and year-to-date capital expenditures $45.5 million. We continue to invest in our Unity 20/20 CRM Systems project, as well as plan updates, expansions and automation that will allow us to achieve our long-term strategic objectives. As previously communicated, we expect capital expenditures in fiscal 2015 to be between $90 million and $100 million. We also continue to look for additional acquisition targets as acquisitions remain an integral part of our overall growth strategy. Cash and cash equivalents at the end of the quarter totaled $231.5 million, up from $191.8 million at the end of fiscal 2014. Of our cash on hand to quarter-end $58 million has been accumulated by our foreign subsidiaries and intended for future investments outside the United States. The company also continues to have significant capacity under its existing bank line of credit to fund potential acquisitions or other capital allocation options. At this time we would like to update you regarding the New England Compounding Center or NECC matter. During the quarter, we along with our insurers have agreed to a $30.5 million settlement, which will be funded entirely by our insurers. As you will recall from our past disclosures, NECC was a pharmaceutical compounding company that made and sold the tainted drug, which reportedly resulted in a widespread outbreak of fungal meningitis and other infections. Our Uniclean division provided a limited once a month cleaning service to portions of NECC’s clean room facilities. The effectiveness of the settlement agreement is conditioned on the bankruptcy court’s issuance of a planned confirmation order that releases us in full and bars all persons from asserting any claims against us relating to this matter. If either of the bankruptcy court’s confirmation order or any resulting appeal adversely affects the releases or injunction than UniFirst or our insurers may terminate the settlement agreement in which case the litigation would resume. While we believe the quality of our services we provided to NECC was appropriate and we were not responsible for the contamination of NECC’s drugs, we also believe this settlement is in the best interest of our shareholders. As always, we would like to provide you with an update regarding our outlook for the remainder of our fiscal year. As discussed earlier, during the quarter, the Canadian dollar as well as the euro has continued to weaken against the U.S. dollar, impacting both our Core Laundry operations, as well as our Specialty Garment segment. At the current exchange rates, it is estimated that our full year revenues would be impacted by approximately $8 million, compared to the projected revenues using exchange rates assumed when we originally provided guidance in October. In addition, our revenues over the remainder of the year will be negatively impacted by reductions in wearers that we have already experienced in energy related markets in the U.S. and Canada. We also anticipate we will continue to experience further reductions of wearers if oil prices remain at current levels. Although some levels of further declines have been built into our guidance, it is very difficult to project how long and at what depth our results will be impacted. As a result of these factors, we expected our revenues for fiscal 2015 will come in at the lower end of our previously communicated range of $1.45 billion and $1.47 billion. We also expect full-year diluted earnings per share will be between $5.65 and $5.85. Our earnings guidance has been lowered from levels previously communicated, primarily to reflect the impact of the environmental charge taken during the quarter. As we discussed last quarter, we believe that if oil prices remain depressed for an extended period of time, our overall operating results will be negatively impacted, due to our significant presence in these energy related markets. Although we are currently benefiting from lower energy cost in the form of lower gasoline cost, we believe that at current prices the negative impact of the economic slowdowns in these markets would outweigh the benefit of lower energy cost. This completes our prepared remarks and we will now be happy to answer any questions you might have.

Thank you, sir. [Operator Instructions] Our first question comes from the line of Andrew Wittmann with R.W. Baird. Your line is open, please proceed.

Good morning guys.

Good morning.

Good morning.

I wanted to dig into the energy impacts and try to get some little bit more detail around that. Just implicit from the low end of guidance, it looks like that implies about a 2% organic growth rate by our calculations and previously you mentioned that your energy exposure was in the high single digits, if you go from what you are growing before 6%, 7% organically, the 2%, that’s about a 5% difference in implicit in the revenue levels. Is that suggesting that your energy wear account is down by half or how should we be thinking about the magnitude that you are guiding here in the second half.

I think the issue and the math you are doing there, Andrew is that if you looked at our guidance at the beginning of the year, whether it be at say the mid-point of the range, it was already implicitly assuming some deceleration of organic growth. I think going into the beginning of the year, we sort of indicated that we didn’t think that 6%, 7% was really sustainable over a longer period of time and that later in the year it would probably flatten out a little bit closer to mid-single digits. So, some of that was already sort of assumed by sort of where we were tracking versus prior year, which was a very strong third and fourth quarter. So, I don’t think, you certainly shouldn’t be looking at the decline of 7% or 6% to what we are assuming over the second half of this year as entirely oil related at all. The impact that we are probably assuming over the second half of the year is half that if not even a little bit less related to oil in particular.

Got it. Can you talk maybe about the extent of the support industries around those energy related geographies and the level of impact you are seeing there. I mean Ron you’ve been in the business for long time and usually there is some level of crossover there, give us a sense about where we are today relative to where we could be if things stay weak here?

We really don’t know. I mean we keep talking to our guys. We have about 13 locations affected by this. So, we keep talking to our guys, one guy says it’s flattening and another guy tells us it is still going down, but it’s to start the driller or the rig guys, it is the trucking companies that bring in the pipe, it’s a pipe manufacturer in South Carolina and we are seeing it all up and down, and West Texas and Edmonton are being hard hit. They used to – to get a job at McDonald's, they were paying $12 an hour plus $2500 bonus. If you stay in 60 days at McDonald's in Odessa, all that’s gone away now, now they are back to paying $9. We can’t give you a hard direction.

Yeah, I will take the follow-up on that and I mean Ron’s right, I think we have heard anecdotally in talking to some of our managers that it is not just the oil companies that have been effected, there has been some downstream impact, but where that is in the cycle is very difficult to tell. I think a lot of these oil companies are still feeling their way as well because they are trying to continue their operations and trying to keep their headcounts as strong as they can, but they are still waiting to see how long this factor is going to impact them. So, it’s something we are just going to have to continue to watch and it’s difficult to say right now where we are in this cycle.

Okay, if you can afford me one more question, Steve, I want to dig into the margins that are imposing the guidance as well. It looks like for the second half of the year, you’re guiding margins down, one can you confirm that? Looks like regarding, maybe significantly down, can you talk about – is that a result of some of the deleverage you are seeing from this wearer loss, which has historically been higher margin business or is there something else going on there, other cost coming in the system.

So, there is a couple of different things. Yeah, I think part of that is the deleveraging we are expecting to see in some of the – connected to some of the revenue declines we are assuming. Some of that also is some continued higher merchandise we are starting to see, you know sort of unrelated to the oil situation, you know we’ve talked about healthcare costs, I didn’t mention them. This quarter they have been coming in higher than the prior year, not quite to the level that we thought they might coming into the year, but we are probably still being a little cautious on the remainder of our year forecast for our healthcare cost because it is still early in the cycle of our new plan. So some of that’s implicit. Part of the margin decline that’s being assumed relates to the impact of foreign currency, and these are just smaller pieces that I’m giving you now, but for example, our Canadian business, which is about 8% of our business, obviously is being impacted by the exchange rates. A lot of the merchandize that the Canadian business buys, it buys from outside of Canada. So, it’s becoming more expensive for them to buy merchandize in Canadian dollars from outside the country. So, there is certain things like that that are starting to come into effect as well.

Yeah one of the key factors you mentioned there early on was the merchandize cost, I mean that’s probably a result of new sales though, is there something else going on with the merchandize or that’s just because you’ve sold new business and so you have to put new merchandize in business into the cycle?

It is probably two or three things. I mean certainly with our continued relatively strong levels in new sales, you will continue to have that new merchandise. Adjacent to the oil situation, you also have these reductions that we are experiencing, but sort of the accounting mechanism for merchandises that it continues to amortize over a useful life. So, just again one example, Ron mentioned Odessa, Texas, we are pulling out a tremendous amount of uniforms that we are not getting revenue for now, but they will continue to amortize their useful life. Now if you remember back in 2008, 2009 eventually as we started to redeploy those garments as things pick back up, our merchandize cost dipped because we were actually putting in merchandize that probably was somewhat fully amortized. So there’s a little bit of that going on probably over the second half of the year as well.

Okay. Great, I will leave it there. Thanks guys.

Thank you.

And our next question comes from the line of Nate Brochmann with William Blair. Your line is open, please proceed.

Good morning gentlemen.

Good morning.

I wanted to just dig in and I get that it’s hard to predict and I get that the ancillary industry is that, affect oil are also kind of hard to judge, but where would you say we are on the curve in terms of energy customers beginning to adjust, I mean are we at the very beginning to the curve in terms of what you are starting to see in terms of the trends accelerating in terms of some of those employees falling up, or are they just falling off at a gradual rate and we will kind of wait and see how that progresses?

I think more the latter Nate. We really started seeing a pick-up late in January into February and it’s probably reached its higher point in early March. Like Ron said, some of our managers in certain locations are seeing their customer base maybe stabilize a little bit, others it continues. I mean, we watch it every week and we have not seen it stabilize yet, we continue to see weekly reductions at similar levels as through most of March and February and that’s why it’s so difficult. If we had had two or three weeks where it had flattened, we’d probably be more confident in saying maybe, there may be adjustments they are going to make, but we haven’t really seen that trend yet, which is why it’s difficult to see when it’s going to end. It’s very similar to 2008, 2009, not at the same depth, but during that year, until we saw the reductions for a four week period stabilize we really didn’t know where we were in the cycle.

Sure that makes perfect sense. Okay, that’s helpful. And then second though, if we like getting rid of the energy impact and we get rid of the currency impact, I mean does sound like the Core business obviously is performing very well and even though you didn’t mention it specifically it sounds like kind of maybe Add-stop metric would give or take maybe the neutral to slightly positive at this point, but we haven’t – again I’m stripping out the energy impact. So, underlying trends for the overall economy and employment in the core business minus energy sounds like it’s still progressing pretty well. Would that be fair to say?

Pardon me, ladies and gentlemen, the speaker line has disconnected, one moment while we get the line reconnected. And ladies and gentlemen, we are now back in conference. Pardon the interruption, Mr. Sintros, I will turn it back over to you. The line of Nate Brochmann had disconnected, so we will move on to the next question. The next question comes from the line of John Healy with Northcoast Research. Your line is open, please proceed.

Thank you. Steve. I wanted to ask a little bit about the environmental charge I was taking in the quarter, is there any sort of impact that’s planned in 3Q and 4Q or even that we should expect in the next fiscal year just as it relates to the activity going on there, is there any sort of change in expectations for overall cost?

John, at this point there is not any expectations. This is a site that has been a site that we’ve been dealing with over the years, had been relatively quiet and not much going on until this municipal project came up. At this point the project in its early planning stage is in the cost that we’ve estimated so far are our best estimate of the cost to handle this situation at this time. As we learn more about the project and the project develops there certainly could be changes in those estimates, but at this point we are not projecting any in particular.

Great. It was helpful to get the update on the litigation item, curious to know if you guys have any thoughts or expectations when you might have feeling of when the final say or the final decisions will be made regarding the settlement?

That’s a good question. There’s a couple of different trigger points that I talked about. We talked about the bankruptcy Core sort of affirming the order that’s probably something that will likely occur in event over the next maybe three to six months. And then the other thing I mentioned would be is there any potential appeals, we will just have to wait and see if that happens and if that happens you will probably have to add some time to that time frame. So, we will continue to keep everybody updated through our disclosures, but I think this development was a step in the right direction.

Got you. And then just lastly, I want to ask Ron, in the prepared remarks you guys mentioned the acquisitions continue to be a big part of what you like to do and a part of the plan and then you have the dry powder to do it, any update in terms of the pace that you are looking at deals if it feels different then it has in quarters passed, type of properties that are out there, any sort of color that you could provide there would be great?

Well I think, we are basically out there, we are trying to sell them on the pack and try to sell their business. There are not a lot of guys raising their hand that come talk to me or out there saying, we have a better alternative for you in trying to convince them to sell their business. That’s kind of my answer on that.

Okay. Thank you guys.

Thank you.

[Operator Instructions] Our next question comes from the line of Andrew Steinerman with J.P. Morgan. Your line is open. Please proceed.

Hey, Steve, I actually have a couple of questions. The $5.65 to $5.85 which is reduced by $0.13 at the midpoint includes the $0.10 charge from environmental if I am catching this right. And so if it was not for this charge or another words, if we excluded the charge from the guidance, the guidance for EPS really wouldn’t have changed much may be $0.03 at the midpoint, right?

That is correct, Andrew. The comment I made is that, the primary reason for the decrease from the previous numbers in the environmental charge.

That’s right. So I would just…

It will be partly [ph] changed if it wasn’t for the charge.

Right. So I would just exclude that and then Steve, can we really understand there was a question earlier when someone talked to you about the deceleration applied in the second half. Was that all related to oil and you said not all related to oil and when I look at the press release, it says we will be at the low end of the revenue range because of a weaker dollar and oil, and we definitely understand that oil portion of your customer is more uncertain. But what would be any other factor that’s leading to a lower end revenue assumption other than Canadian dollar and oil?

I think to clarify, the reason we’ll be at the lower end of the range is the Canadian dollar and oil. I think the question was why the deceleration of organic growth is at all oil related? And my answer was that, even at the midpoint of our original revenue range, there was assumed deceleration of growth in the second half of the year just from a timing perspective and year-over-year where we thought growth was going to be regardless of oil. And so hopefully that clarifies that. I mean the reason why we are coming in at the lower end is oil and exchange rate related. But if you assume that we were going to be in the midpoint and model that out over the rest of the year, it would show that there would be some deceleration of our organic growth regardless.

Great. But could you point to a reason or is that just natural conservatism numbers further out. We don’t know it much about.

I don’t think its natural conservatism. I think it would be us saying that we don’t feel that 6% to 7% is sort of our sustainable organic growth. We had a strong second half of the year last year and we saw a leveling of the growth based on the factors, non-oil related.

Got it. Steve, I got you. You’re saying its mean reversion. Last point, Add-stop growth without oil was at neutral or could you just make one comment on add-stops without considering energy clients?

Yeah I think that’s the question I was answering when the phone got cut off. He probably didn’t hear all of my answer. But the adds reductions net of oil while I don’t have that exact number are probably slightly better than they were last year at this time. So in general, I think the rest of the business no real red flags there on negative trends. Without the numbers in front of me, I’d be hesitant to say that those were positive through six months. They’re probably still slightly negative or flattish which is probably a little better than they were last year at this time, but oil being the biggest driver.

Great. Thanks for all the time.

Thank you.

And gentlemen, I’m showing no further questions on the phone at this time. I’ll turn it back to you for your closing remarks.

Okay. We would like to thank everyone for joining us for the review of UniFirst latest financial results for the second quarter of fiscal 2015. We look forward to speaking with you again in July when we are reporting our third quarter numbers. Thank you and have a great day.