UniFirst Corporation (UNF) Q1 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the First Quarter Earnings Call. During the presentation, all participants are in a listen-only mode. And we’ll later have a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Steve Sintros, President and Chief Executive Officer. Please go ahead, sir.

Thank you, and good morning. I’m Steven Sintros, UniFirst’s President and Chief Executive Officer. Joining me today is Shane O’Connor, Senior Vice President and Chief Financial Officer. I’d like to welcome you to UniFirst conference call to review our first quarter results for fiscal 2019 and to discuss our expectations going forward. This call will be on a listen-only mode until I complete my prepared remarks, but first, a brief disclaimer. This conference call may contain forward-looking statements that reflect the company’s current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties. The words, anticipate, optimistic, believe, estimate, expect, intend, and similar expressions that indicate future events and trends identify forward-looking statements. Actual future results may differ materially from those anticipated depending on a variety of risk factors. I refer you to our discussion of these risk factors in our most recent 10-Q and 10-K filings with the Securities and Exchange Commission. I’m happy to report that UniFirst’s first quarter of fiscal 2019 produced solid results for both our company and our shareholders. Overall, revenues for the quarter reached an all-time high, coming in at $438.6 million, up 5.5% from last year’s first quarter. On the profit side, fully diluted earnings per share for the first quarter was $1.99, compared to $1.67 for the same quarter a year ago. It should be noted that this comparison of quarterly earnings per share was positively affected by the U.S. tax reform, as well as the buyback of 1.178 million shares of Class B and common stock in the third quarter of fiscal 2018. As expected, the margins in our Core Laundry Operations were challenged primarily by higher payrolls, as well as increases in merchandise amortization and related costs. These areas impacted our quarterly results at higher levels than originally anticipated. As we look ahead to the remainder of the fiscal year, we continue to project these headwinds to impact our operating margins at elevated levels. In addition, as I’ve mentioned previously, we continue to make significant investments in our people, our technologies and our overall service infrastructure. We’ll be working diligently with our team partners, as well as our thousands of business customers to help mitigate the impact of these costs on our profits in the short-term, without sacrificing our overall objective of being universally recognized as the top service provider in our industry, which we believe is a crucial component to creating long-term value for all UniFirst stakeholders. I’d like to sincerely thank all of our thousands of employee team partners throughout North America, Central America and Europe for their continued commitments to our customers and to our company, and for all their hard work to help produce positive financial results for UniFirst. As always, we will continue to count on our Core Laundry Operations to continue driving the lion’s share of the company’s revenue and growth. Excellence in customer service continues to be the focus of all we do at UniFirst. As such, we’ll continue investing in our service teams to ensure improvements in our service quality and consistency and, of course, we’ll look to our field and national account sales teams to continue improving productivity, the result of our ongoing investments in training and prospecting technologies. By focusing on these business essentials, we expect to drive higher growth rates through improvements in customer retention and satisfaction levels, as well as improvements in new customer and ancillary service sales. As we disclosed in our financial press release earlier this morning, our Board of Directors has authorized management to repurchase up to $100 million of UniFirst common stock. As I just mentioned, our top priorities continue to be investment in the growth of our business and the enhancement and the quality of our service offering. However, our strong balance sheet and healthy cash flow position allows us the opportunity to continue investing in strategic growth drivers, while simultaneously pursuing opportunities to deploy capital and create additional value to our shareholders. And with that, I’d like to turn it over to Shane, who’ll provide additional details on our quarterly results and our outlook for the remainder of fiscal 2019. Shane O’Connor: Thanks, Steve. Revenues in our first quarter of 2019 were $438.6 million, up 5.5% from $415.8 million a year ago, and operating income for the quarter was $50.4 million, compared to $51.9 million in the prior year period. Net income for the quarter increased to $38.3 million, or $1.99 per diluted share from $34.2 million, or $1.67 per diluted share in the first quarter of 2018. Both our operating income and net income benefited from a $3 million pre-tax gain we recognized in the first quarter of 2019 related to the settlement of environmental litigation, which equated to $0.11 per diluted share. Our net income comparison in the quarter also benefited from a lower tax rate in 2019 of 26.2%, compared to 35.5% in the prior year period, primarily due to the positive impact of the recent U.S. tax reform. In addition, our adjusted diluted earnings per share further benefited from our buyback of 1.178 million shares of Class B and common stock in our third quarter of fiscal 2018. Our Core Laundry Operations, which make up approximately 90% of the UniFirst total business, reported revenues for the quarter of $390.5 million, up 4.5% from the revenues achieved during last year’s first quarter. Adjusting for the estimated effective acquisitions, as well as the impact of a weaker Canadian dollar, our Core Laundry revenues grew 4.1%. During the quarter, our organic growth continued to benefit from solid new account sales, as well as the timing of customer price adjustments and increases in merchandise recovery charges. Core Laundry operating income was $44.8 million for the quarter, down from $46.4 million in the prior year period. The segment’s operating margin decreased to 11.5%, compared to 12.4% in the first quarter of fiscal 2018, primarily due to continued wage pressures and its production and service payroll, as well as higher merchandise amortization and depreciation as a percentage of revenues. In addition, energy cost increased to 4.2% of revenues in the first quarter of 2019, up from 4.1% a year ago. These items were partially offset by the $3 million gain we recognized related to the settlement of environmental litigation, as well as lower healthcare claims cost. In addition, during our first quarter, we adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers. This adoption did not impact the timing of our revenue recognition. However, our selling and administrative expenses include a non-cash benefit of $0.9 million in the first quarter of 2019 from the capitalization of sales commission payments and the subsequent amortization of those commissions over the expected service period of the associated customer relationship. Also in conjunction with the adoption of the new guidance, we recorded a deferred sales commission asset of $53.2 million, a deferred tax liability of $13.8 million and we increased our retained earnings by $39.4 million. As anticipated, the segment’s operating income benefited from the capitalization of internal labor costs during the quarter related to the CRM project we kicked off in our fourth quarter of 2018. However, this benefit was largely offset by costs incurred related to the timing of certain selling promotional events. Revenues from our Specialty Garments segment, which delivers specialized nuclear decontamination and cleanroom products and services, increased by 21.2% to $34.4 million in the first quarter and operating income was $4.5 million. As we mentioned in the past quarters, this segment’s results can vary significantly from period-to-period due to seasonality and the timing of nuclear reactor outages and projects that require our specialized services. The segment’s top line benefited from acquisitions in fiscal 2018, that increased quarterly revenues by 11.3%, increased activity from the segment’s Canadian customers and solid growth in its cleanroom division. Specialty Garments’ operating margin decreased to 13% from 15.7% in the prior year period, primarily due to higher costs related to its 2018 acquisitions, as well as higher production payroll, merchandise amortization and casualty claims expense as a percentage of revenues. Our First Aid segment reported revenues and operating income of $13.6 million and $1.2 million, respectively, for the quarter, which were relatively consistent with the segment’s performance in the prior year period. UniFirst continues to maintain a solid balance sheet and financial position with no long-term debt and cash, cash equivalents and short-term investments totaling $276.5 million at the end of our first quarter of fiscal 2019. Cash provided by operating activities in the quarter was $32.3 million, a decrease of $15.4 million from the comparable period in the prior year, when cash provided by operating activities was $47.6 million. This decrease was primarily due to the payout of the previously announced $7.2 million one-time bonus to our employees in September of 2018, as well as increases in merchandise and service negatively impacting the comparison. For the first quarter, capital expenditures totaled $23.3 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. During the quarter, we capitalized $1.8 million related to our CRM project, which consisted of both consulting costs and capitalized internal labor costs. We continue to expect capital expenditures for the full fiscal year to be approximately $130 million. Although we did not acquire any businesses during the quarter, we continue to look for and aggressively pursue additional targets, as acquisitions remain an integral part of our overall growth strategy. I would now like to update you on an item that did not impact our fiscal quarter, but will impact our second quarter. During fiscal 2017, we recorded a pre-tax non-cash impairment charge of $55.8 million, when we determined that it was not probable the version of the CRM system that we had been pursuing would be completed and placed in service. On December 28, 2018, we entered into a settlement agreement with our lead contractor for that project. As part of the settlement agreement, we will report a gain of $20.3 million in our second fiscal quarter of 2019, which includes our receipt of a one-time cash payment in the amount of $13 million, as well as the forgiveness of amounts previously due to the contractor. As always, I’d like to take this opportunity to provide an update on our outlook for fiscal 2019. At this time, we continue to expect that our fiscal 2019 revenues will be between $1.765 billion and $1.785 billion. As Steve previously mentioned, during the quarter, we experienced larger-than-anticipated increases in our production and service payroll costs, as well as our merchandise amortization. Now as we look forward to the remainder of the year, we anticipate that the headwind from these items will be greater than our original expectations. These increases are projected to be only partially offset by lower energy costs for the year compared to our original forecast, the result of recent fluctuations in fuel prices. As a result, we now expect full-year diluted earnings per share will be between $6.65 and $6.90. This guidance excludes the impact of the CRM-related settlement agreement that we will recognize in our second fiscal quarter of 2019. Also, 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. This concludes our prepared remarks, and we would now be happy to answer any questions that you may have.

Thank you very much, ladies and gentlemen. [Operator Instructions] And our first question is from Andrew Wittmann with Baird. Please go ahead.

Great. Thanks and good morning. Hi, guys.

Good morning. Shane O’Connor: Good morning.

I think the most helpful thing and where everybody is going to be focused today is going to be on your margins, so I want to start there. We did the math that the sales accounting for the commissions is about 20 basis points help to your margins, you said that energy was 10 basis points. Steve or Shane, can you just help us with some of these other big buckets that you mentioned and talk about that the magnitude of them, the wage, how much of that was – how much of the headwind from that merchandise, how much of a headwind was that depreciation and health care, I think would be helpful to give us some context about how the quarter came in? Shane O’Connor: Okay. When we take a look at the selling costs that you mentioned, but when we originally guided into the year, right, the selling costs we had taken those into account and those were largely in line with our expectations, as well as our forecast for the remainder of the year. When I take a look at, I guess, the margin decline that we’re sort of forecasting for 2019, it really is predominantly driven by the merchandise, as well as the service and delivery payroll costs that, not only are we talking about here today in Q1, but we sort of talked about and indicated that we were going to be experiencing elevated levels going into 2019 during our last call. So as I look at where we’re forecasting currently 2019 to be, merchandise – direct merchandise amortization costs are probably going to be about 50 basis points higher than our prior year. Our payroll costs are going to be up 70 basis points to 80 basis points. We’re going to incur additional merchandise-related costs, which is primarily the costs related to our distribution center. And those are driven not only by additional labor costs related to the merchandise that we’re putting into service, but also increased freight costs of 20 basis points to 30 basis points. So those items right there are really driving the majority of the margin swing that you’re seeing.

Got it. That’s super helpful. Do you want to talk about the – I guess, at least in the quarter, healthcare was a positive? Is that in the forecast to be a positive for the balance of the year as well, Shane? Shane O’Connor: No. Coming into 2019, we had sort of forecasted that our healthcare costs were going to be up slightly coming off of 2018. We did experience a benefit in Q1 compared to those two – what our forecast was, as well as compared to our experience in the first quarter of 2018. But at this point in time, we really haven’t factored in additional benefits going forward. I mean, as you probably recall, the healthcare claims expense that we incurred through 2017 and 2018 was very variable by quarter. So at this point in time, we don’t think it’s prudent to be continuing to forecast that benefit.

Okay. I’m just going to do one more for now. I’ll yield the floor and then come back, maybe later with some cleaner questions just, but it would be more modeling-related. But just related to the 50 basis points that you’re modeling for the merchandise cost, outside of the distribution center and the freight costs, the stuff that 50 basis points are really merchandise. What’s driving that? Is that labor in those plants that are offshore? Is that input costs? Just maybe a little bit of context on that would be helpful?

Sure. Sure, Andy, this is Steve. It’s really not the input cost in the merchandise and fabric, and some of those things are up a little bit. But what’s really driving it is the quantity that’s being placed in service. Now part of that is from what was coming off of a strong 2018 of new account sales that you know when you have strong new accounts sales, there’s an associated merchandise cost that kind of outweighs the benefit of new account sales through the first turn of that merchandise amortization. But really the larger part is an increase in what we call replacement merchandise, which is not for new accounts, but for just normal garments being worn out, renewal of contracts, redressing of accounts, and that really ebbs and flows over the years. And really over the second-half of 2018 and more than expected in the first quarter of 2019, we’ve really seen an acceleration of those garments being placed in service. And we’ll be honest, it’s a little bit difficult to get our arms around, because it’s fairly widespread across our locations. And when you dig in, it’s a lot of different situations, some of that can be competitive pressures, some of that can simply be customers that are changing style and trying to keep up with the needs of our customers. But we are trending higher in that area and it’s more of a quantity of the inputs versus the cost of the fabric of the production.

Super helpful. Thank you. I’ll yield the floor.

Thank you.

Our next question is from John Healy with Northcoast Research. Please go ahead.

Thank you. Steve, I wanted to ask kind of a big picture question and I ask this question with a lot of respect to the company and the history of the company. But when I listened to your last couple of conference calls and kind of the comments today, there’s some spend that taking place, whether it’s wages, whether it’s service levels, whether it’s garments. As you guys look at the business and Shane as you’re kind of now running it yourselves, is there a level of investment that you’re doing in the business to – I don’t want to call it, catch up, but to maybe get back to a level that is allowing you to maybe take market share over the long run, or I mean, is 2019, we’ve talked a lot about the cost. But is it really just a year to kind of step back up than maybe there were some costs that were deferred and philosophically we’re just kind of – just being a little bit tighter with the buck and the investment that you guys have had historically?

It’s an excellent question, John. And I think the short answer to the question is, yes. I mean, I think – and I think, you read our comments correctly in that and I’ll break it down into a couple of different areas. I think, there’s the, what I’ll call, sort of infrastructure investments, which go back to the capabilities and some of it’s on the technology side and the stories on our technology project has been well told at this point. But – so some of it is in those areas. But I think, the other side of it on the wage side, I think, where those two things are intersecting is that, we’re obviously going through a couple of years here where the availability in the cost of labor is increasing significantly. And I think, what we’re finding is that in the environment, where unemployment was 5%, 6%, 7%, 8%, 9%, 10%, we were able to hire and retain good people and keep our production and service staffs stable. I think, your comment about investments is correct, but I think it’s also intersecting or colliding, if I want to call it that with an employment environment that’s very challenging and one where I think, we’re finding ourselves chasing it a little bit. And I think, we’re trying to get ahead of it in terms of the wages on both of the service and the production side to stabilize those teams, because I think, although, our 2018, we were able to keep margins a little bit more in check. There was a fair part of the year that we were understaffed quite a bit in, particularly the service area, but even in the production area, which forced us to rely on – in the production area a lot of temporary labor. And in the service area scramble to make sure we could cover our routes and be as solid on the service side as our customers expect us to be. And so I do think overall, there’s some reinvestment going on, and I think it’s also colliding with the current environment.

Great. That’s very helpful. So along those lines, the reinvestment part of it, is that complete do you think after fiscal 2019, or do you think that some of the spend, the lingers or carries over the incremental spending to 2020? Obviously, I imagine, it will stay in the cost structure, but just trying to think about the stair step to it?

Yes. I think that the growth of it will certainly moderate. And I think it’s our commitment to make sure it moderate, because we understand, there’s only so much we can absorb over a reasonable period of time. But I think we’ve added some to our infrastructure, like this is just one example and I don’t want to put too much weight on it. But there’s certain services we’re looking to sense by to provide more consistency of execution to our customers. And right now, we’re in the midst of staffing up to centralize some of those things, and we have not pulled the requisite labor out of the field, because we’re sort of in a training and ramp-up mode on some of those centralized services. Again, I don’t want to put too much weight on that one item, but that’s an example of an item of the transition we’re going through. So some of it, I think, we can pull some cost back, as we get – as we absorb it. Some of it, as you said, the cost will be in our infrastructure, but not at the same level of growth we’ve been experiencing over the last couple of years.

Great. And just one final question for me. It’s a question about energy with gas prices coming in a little bit here. How have you seen your kind of oil markets kind of perform? Is there any sort of change in trend there? And then what is – what’s kind of the exposure to the oil and gas these days for you guys?

Yes. I don’t have the exact exposure number. I mean, I think, we – when we had got into the kind of the floor, we were down around 5%, that’s probably ticked up a little bit with some of the rebound in West Texas. Again, as we’ve talked about in the past, the exposure on the energy side is more the geographies we operate in versus just the direct energy customers. As we talked about in the last couple of years, West Texas has come back, not near the level that they were at in, say, 2014 or 2015, but a solid bounce back year in 2018. They’re still going. I’m sure this recent pullback will cause there to be some pullback in that sector. But other than West Texas, the other energy markets like Edmonton and Oklahoma City and Tulsa and Corpus Christi, none of those really had the strong recovery that West Texas did. And so right now, I don’t think there’s as much exposure to the downside of the reach – recent energy pullback. But there’s probably some as it relates to our Odessa operations.

Okay, great. Thank you, guys.

Thanks, John.

And our next question is from Andrew Steinerman with JPMorgan. Go ahead.

Good morning. I just wanted to understand how the $0.11, the settlement, the environmental litigation fits into the EPS guidance. Is the $0.11 included in the $6.65 to $6.90? And also, a quarter ago, when you gave guidance, did you have any assumption for a litigation gain? Shane O’Connor: Okay. So at this point in time, the $0.11 coming from the settlement is included in the EPS guidance. A quarter ago when we provided guidance, it was not included. When you take a look at the quarter, obviously, we got that benefit from the settlement, as well as the healthcare claims expense that we spoke about. But the merchandise and the production payroll increases that, that we experienced mostly offset those. Net of those items, our quarter really wasn’t that far off from, maybe what our regional expectations were. But again, the increases in those two areas and sort of the impact that we’re now forecasting for the remainder of the year is really shadowing that, that EPS guidance.

Okay. And the likelihood of other litigation gains is reasonable or not likely? Shane O’Connor: Yes. Other than the CRM-related settlement that will hit our Q2 numbers has been excluded. We’re not expecting any other near-term gains.

Okay. Thank you.

Thank you.

Our next question is from Tim Mulrooney with William Blair. Please go ahead.

Yes, good morning. I wanted to start on organic growth. Do you still expect 2.5% to 3.5% organic growth for the full-year and your uniform rental business? This would imply a slowdown from what you did – what you just did in the first quarter. So if you are maintaining that guidance, are you seeing any changes in the macro environment, or is it just more a function of more difficult comps in the few upcoming quarters? Thank you. Shane O’Connor: Yes. At this point in time, we are projecting that our organic growth rates are still going to be between that 2.5% to 3.5% range. One of the things that we are forecasting is going to impact maybe our original assumptions would be the decline in the Canadian exchange rate and its impact on our Canadian-denominated revenues. And that – the decline that we’re seeing there is partially offset by potentially higher than originally anticipated direct sale revenues. As it relates to the – I guess, the organic – or the slowdown of our organic revenues, sort of as we had indicated in our comments, our quarter – our first quarter benefited from some of the timing of certain pricing adjustments, as well as increases in merchandise amortization costs that we’re not necessarily forecasting or going to be fully felt the remainder of the year.

Great. Thanks, Shane. Moving on to your free cash flow guidance, given the updated guidance range that you gave today on earnings in the CRM settlement, do you still expect free cash flow in that $65 million to $70 million range? Shane O’Connor: Yes. At this point in time, I still believe that that’s probably an appropriate range. I know in the first quarter, we didn’t generate a whole lot of free cash flow. And I guess, first off, our first quarter normally isn’t a heavy cash flow quarter based on the timing of annual bonuses, as well as some other working capital items. There’s some seasonality in our receivables balances, et cetera. In addition, we had some elevated CapEx, but we’re projecting obviously for the year higher CapEx number. And the free cash flow that I had originally projected sort of had some larger working capital assumptions throughout the year. That combined with the fact that, we will be receiving $13 million related to the settlement that was recently signed, it will be recognizing in our second quarter. I think that the free cash flow assumption is still a solid.

Okay. Thank you.

Thank you.

And we have a follow-up from Andrew Wittmann. Please go ahead.

Yes, great. So I just want to level set the CapEx since we’re talking about here. Steve, can you maybe said this in the script, I missed it. But the IT spend on the new CRM was what? I just want to get a sense here of what the CapEx budget is for kind of everything else, assuming that – and this is a simple fine assumption. But assuming that the IT spend is kind of a one-time program and everything else is more normalized. I just want to check your capital intensity in compared to some of your peers and by breaking out the IT separately, that would help us do that?

Yes. I could actually speak to that. During the quarter, we capitalized $1.8 million against the project. And sort of at the end of the – or at the end of our fiscal 2018, we had guided that – we assume that our spend during the year would be between $5 million and $10 million, and we still believe that, that is the case related to that project. So excluding that, obviously, our CapEx is going – or is going to be approximate $125 million. I think, we had also spoken to the fact at the end of our last quarter that our assumptions for CapEx over the next couple of quarters is going to be higher than maybe our long-term run rate at our historical run rate, primarily, because we’re prioritizing some of these facility additions and expansions over the next couple of years, maybe in comparison to, I guess, the rate at which we had been building those facilities out in the past.

What’s the – so that’s about 7% of this year’s revenue guidance. What’s the right number longer-term after we get through, maybe a couple of these elevated things for UniFirst at your size and scale with the growth profile that you guys are projecting, if you look at CapEx as a percentage of revenue? Shane O’Connor: Yes, probably 5% to 6%.

Okay. Shane O’Connor: It should come down a little bit after we get through a couple of years, at least, as a percent.

Yes. And then just kind of one check in here just on sales force productivity, and it sounds like you guys are making some investment to give these guys some better tools and training always kind of something that UniFirst does. What are you seeing in that trend in terms of what you guys and gals are able to produce? And how accommodative is the market today? Are you seeing any sign at least talking about slowdown? But I’m just kind of curious as to what you’re seeing out there?

I think, we’ve been fairly successful and we talked about coming out of fiscal 2018 having really the best sales year the company has ever had. And I think the productivity of the team on a head – per rep basis was certainly elevated in 2018 so far through 2019. We’re at least at the same level as where we were when we started 2018. I think, the market is fairly receptive. And I think that’s why you hear me talk more on the service side. We still believe that’s where the opportunity exists. I think new accounts are there to be sold. There’s opportunity certainly to take share where customers are looking for other options and I think where we’ve been taking advantage. The two issues we need to do a better job is certainly on the retention side. And then in this environment, I think, one of the challenges not only with the company, but in the industry is that the price that new accounts are getting sold for and we talk about consolidation in the industry hasn’t really changed significantly, not only in the last couple of years, but really over the last five-plus years. And so that is the challenge of these escalating wages that new accounts sales are still going in at reasonably the same starting prices and it’s putting more pressure to increase price as we go along the way with our customers, given the higher wage increases and so on that, that we’re experiencing. So it’s really that balance and that’s why it makes it so much more important once we sell these accounts to make sure we’re retaining obviously as many as we can.

Very helpful. Thank you very much.

Thank you.

And gentlemen, we have no other questions at this time.

Okay, great. I’d like to thank, everyone, for joining us today to review UniFirst’s first quarter financial results. We look forward to speaking with you again in March when we expect to be reporting our second quarter results. Thank you, and have a great day.

Ladies and gentlemen, that concludes our call for today. We thank you for your participation. Everyone, have a great rest of your day, and you may disconnect your lines.