UniFirst Corporation (UNF) Q3 2021 Earnings Report, Transcript and Summary

Good morning everyone and greetings. Welcome to the UniFirst Corporation Third Quarter Earnings Call. During the presentation, all participants are in a listen only mode. Afterwards, we will have a question-and-answer session. [Operator Instructions] I'd now like to turn the call over to Steven Sintros, President and Chief Executive Officer. Please go ahead.

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 third quarter results for fiscal year 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 several quarters, I want to start by saying that first and foremost, our thoughts are for the safety and wellbeing of all those dealing with the impact of the COVID-19 pandemic. Good news is that during the quarter, we have seen real improvement from a health and safety standpoint, both in our company and in our communities related to COVID-19. I also want to, again, highlight that for over a year now, our team partners have continued to put forth tremendous efforts in the face of many obstacles created by the pandemic. They have worked extremely hard to take care of each other and our customers during these challenging times, and I want to personally thank them for their extraordinary performance. Consolidated revenues for our third quarter were $464.3 million, up 4.2% from the prior year and fully diluted earnings per share were $2.21 up from a $1.12 in the third quarter a year ago. Our core laundry operations revenues were positively impacted by a modest level of customer reopenings as well as increases in the sale of PPE. Our Specialty Garments segment also contributed to our overall performance with a very -- with very strong results during the quarter that exceeded our expectations. Shane will provide with the details of our quarterly results shortly. Clearly our comparisons to the prior year third quarter are being positively impacted by the significant effect that COVID -19 pandemic had on our fiscal 2020 third quarter. As a reminder, that quarter a year ago was the quarter most impacted by customer closures during the pandemic. Overall, we are pleased with the results of our quarter, which exceeded our expectations from a top and bottom line perspective. Increased business activity from a recovering economy is a welcome sight for sure after a challenging year. In addition, we have started to see early signs of improved activity in the energy dependent markets that we service. Our new account sales and account retention experience were solid during the quarter, and we continue to position our sales resources to take advantage of current opportunities as well as capitalize on future opportunities as the economy recovers. As I'm sure many of you are aware, we are operating in an increasingly inflationary environment. The cost of labor as well as other business inputs are clearly on the rise. In addition, we expect and have begun to experience a rebound of several costs that trended significantly lower during the pandemic such as merchandise, healthcare, energy, travel, and others. For example, merchandised amortization for the full year fiscal 2021 is running at least 100 basis points lower than more historical levels. As we look ahead beyond our fourth quarter into fiscal 2022, we expect that the increases in these costs as well as the inflationary impact on labor and other business inputs will pressure our margins. We will provide you with further insights into our outlook for fiscal 2022 during our fourth quarter earnings call. Our solid balance sheet positions us well to meet our ongoing challenges. We'll continue 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 infrastructure, and our technologies all of our investments designed to deliver solid long-term returns to UniFirst stakeholders and are integral components to our primary long-term objective to be universally recognized as the best service provider in the industry. We continue to make good progress on these core initiatives such as our CRM systems project. Our CRM deployment is certainly a foundational change to our infrastructure that will allow for service improvements and efficiency moving forward. We will continue to invest in our infrastructure and 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. As always, we will 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. And with that, I'll turn the call over to Shane who will provide the details of our results for the third quarter.

Thanks, Steve. As Steve mentioned, consolidated revenues in our third quarter of 2021 were $464.3 million, an increase of 4.2% from $445.5 million a year ago, and consolidated operating income increased to $54.2 million from $27.7 million or 95.5%. The net income for the quarter increased to $42 million or $2.21 per diluted share from $21.3 million or $1.12 per diluted share. Our effective tax rate in the quarter was 22.9% compared to 21.8% in the prior year. As a reminder, our tax rate can move from period to period based on discrete events, including excess tax benefits and deficiencies associated with employee share based payments. Our Core Laundry revenues for the quarter were $409 million, an increase of 5.3% from the third quarter of 2020. Core Laundry organic growth, which adjusts for the estimated effect of acquisitions as well as fluctuations in the Canadian dollar was 4.3%. This increase was primarily driven by the COVID-19 pandemic, significantly impacting our customers' operations and wearer levels in prior year, which was partially offset by a large $20.1 million direct sale also in prior year. As Steve discussed, our quarterly top line performance exceeded our expectations as the impact of the pandemic on our customer base continues to subside as well as from increased sales of PPE. Core Laundry operating margin increased to 11.2% for the quarter from $45.6 million from 5.1% in prior year or $19.7 million. The increase was primarily driven by a number of items affecting our prior-year period, including the impact of the decline in rental revenues on our cost structure, higher costs of revenues related to the large $20.1 million direct sale, higher bad debt expense and additional costs, which the company incurred responding to the COVID-19 pandemic. The current quarter operating margin continued to benefit from certain costs that have trended favorably during the pandemic, including lower merchandise and travel related costs. In addition, the segment's operating results benefited from lower payroll costs due to understaffing caused by the challenging employment environment. Company also relieved some of its bad debt reserves in the quarter that it had provided for during the pandemic as our expectations around future uncollectible accounts have moderated. These benefits were partially offset by higher healthcare claims costs, which trended unfavorably due to what we believe was pent up demand from our team partners deferring elective activities during the pandemic. Energy costs were 4.2% of revenues in the third quarter of 2021 compared to 3.4% prior year. Our Specialty Garments segment which delivers specialized nuclear decontamination and cleanroom products and services, had a very strong quarter and exceeded our expectations in both revenues and operating income. Revenues increased to $38.2 million from $36.2 million prior year, or 5.7%. And were primarily driven by growth in our cleanroom and European nuclear operations. Segment's operating margin increased to 21.7% from 17.6%, primarily due to lower merchandise costs and bad debt expense as a percentage of revenues, as well as costs incurred in the prior year responding to the COVID-19 pandemic. 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 $17.1 million, compared to $20.9 million in the prior year. However, the segment's operating profit was nominal, compared to $1.6 million in the comparable period of 2020. These decreases were primarily due to elevated PPE sales in prior year. In addition, the current quarter operating results reflect 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 $535 million at the end of our third quarter of fiscal 2021. For the first three quarters of fiscal 2021, capital expenditures totaled $96.6 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 $4.2 million related to our ongoing CRM project, which consisted of license fees, third party consulting costs, and capitalized internal labor costs. As of the end of our quarter, we had capitalized a total of $32 million related to the CRM project. In the third fiscal quarter of 2021, we began to depreciate part of this system over a 10 year life and our quarterly depreciation approximated $0.7 million. As a reminder, the depreciation of the full system, combined with additional hardware we will install to support our new capabilities, like mobile handheld devices for our route drivers, will eventually ramp to an estimated $6 million to $7 million of additional depreciation expense per year. Company did not repurchase any shares during the quarter under it's a previously announced stock repurchase program. As of May 29, 2021, the company had repurchased approximately 368,000 shares of common stock for $61.8 million under the program. Based on our results to-date, as well as our outlook for the remainder of the year, we now expect that our fiscal 2021 revenues will be between $1.81 billion and $1.817 billion. We further expected full year diluted earnings per share will be between $7.80 and $8. This outlook assumes that our Core Laundry operating margin in the fourth quarter will approximate 10.6% at the midpoint of the range. This outlook also reflects continued benefits in areas that have trended lower during the pandemic, including merchandise and travel costs. Although, we have also assumed that those benefits will continue to moderate. We further assume that our payroll costs will increase as a percentage of revenues as we work to fill open positions and begin to adjust compensation levels in certain high demand roles in response to the current employment landscape. This concludes our prepared remarks. And we would now be happy to answer any questions that you might have.

Thank you very much. [Operator Instructions] And our first question is from Tim Mulrooney with William Blair. Please go ahead.

Good morning.

Good morning

Good morning.

So, based on the midpoint of your revenue guide, it looks like you're expecting an acceleration in revenue growth from the third quarter to the fourth quarter a little bit. I was wondering if you could comment on how weekly revenue trended through the quarter and how weekly revenues trended through June so far.

Sure. Let me give you a little insight there, Tim. One of the things we talked about in the prepared remarks was some increase in PPE that we had during the quarter. We were able to sell some products that we had good inventories for during the quarter that helped like we mentioned before. During this time of the year, we're usually going into a little bit of a seasonal slowdown in the summer. We haven't really seen that because we're still seeing some recovery of customers and reopenings that would offset a normal seasonal slowdown. So, I think it's been -- I would characterize it as modest and steady through the quarter in terms of recovery. As far as what we're seeing during June, I'd say steady, not necessarily an acceleration. So, I don't want to paint the picture and I don't think we should be painting the picture that there's going to be a significant step up from Q3 to Q4 in terms of further reopenings. For the most part, most of our customers -- there's still some stragglers -- are back in business at some level. We're still seeing shortfalls from the pre-pandemic timeframe particularly in the energy sector, but also others because not everyone's back at the full levels that they were before. So, hopefully that helps provide a little context.

No. That's really helpful. I mean, characterizing it as steady through the quarter, steady through June, but during a period where you'd normally see a little seasonal weakness and not seeing that, so that's really helpful. One more for me before I pass it along. I just wanted to ask about your new account sales. You mentioned your new account sales in your initial opening remarks there Steve, and you said that they were solid, so that's great to hear. I think last quarter, you'd mentioned that they were kind of flattish with last year through the first half of the fiscal year, which was obviously a good result given the pandemic. But have you seen a pickup here at all or it’s still kind of flattish on a year-over-year basis?

Well, I think when you compare it to the third quarter of 2020, which was the -- really the hardest hit pandemic quarter, we're selling more new business. We've sold more new business this quarter than we did that quarter a year ago. So, I would say that it's somewhat improved over the second quarter, but that's why you saw sort of the solid versus spectacular. I think it's solid, and when you look at -- the mix is changing a little bit. There's a need for a lot more ancillary products, and I think we've taken advantage of that through this cycle. The uniform sales are starting to pick up again. So, again, stronger than last year's third quarter. I've drawn the comparison to our fiscal '19, which was a very strong sales year. We're still a little bit short of that. Shane mentioned understaffing, we're a little lower on the number of sales reps we would really like to be carrying right now, to be honest, and we're trying to ramp up a little further as we move into the fourth quarter and into next year.

Got it. Thanks very much, guys.

Thank you.

Our next question is from Andy Wittmann, Baird. Please go ahead.

Thanks. Excuse me, guys. Good morning. I just wanted to get a better sense of the guidance here. You were pretty clear saying that quarter came in above revenue -- above on profit as well. The guidance was obviously raised, but it looks like it's entirely attributable at least in my estimation. So, I'm asking the question that really came from the third quarter, not a change in the fourth quarter. So, I just wanted to kind of check on that, Steve, and see if we're understanding that correctly. And just it looks like -- I mean, you gave us some margin levels, you give us some puts and takes, but can you just talk a little bit more about, I guess, the margin outlook that's implied here, because it looks like the revenue guidance, kind of brackets, what we were already thinking about the margins, probably maybe a little bit softer than maybe I would have thought. So, I just want to understand that in a little bit more detail.

Yes. I'll start and then Shane can provide some details. I mean, in general for the third quarter -- I think, you're right in the way you're kind of analyzing the beat and how it filters to the fourth quarter. The third quarter was obviously strong from a Specialty Garments standpoint. And from a Core standpoint, the quarter benefited from some things Shane mentioned, some bad debt reserve relief as we've felt like we don't need some of those reserves. Coming out of the pandemic things turned out a little bit better in that area than we anticipated. He mentioned some of the understaffing. To answer your question, you really sort of have to go back to the comments I'd made about some of the costs that will start to rise here pretty soon. We've kind of talked about this in the past. Sometimes, these costs take time to rise like merchandise is coming back strong. We've put a lot more in service. It was very unusually depressed for six months or so at the beginning of the pandemic, and even into our second quarter this year. But the last few months, we've really started seeing a surge back in merchandise additions, not just from new sales, but replacements. Almost like the healthcare where during the pandemic, things were -- just activity overall was unusually depressed. And now, we're seeing it come back strong. So, some of that is built into the fourth quarter guidance. And that is certainly some of the caution that we're speaking to as we think forward to 2022. And you heard my comment about merchandise being sort of historically low during fiscal 2021. Shane also mentioned understaffing. It continues to be challenging. We continue to modify wages as necessary for production workers and other positions to attract more workers. We're expecting that to -- to improve over the next few months, whether that'll fully, rectify itself over the next few months remains to be seen. But we do expect that to be a challenge and a headwind, kind of, going into 2022. So I don't know, if that fully answers your question. I can have Shane add to some of the, some of the feedback on the third quarter to give you a sense of that beat and, and why it may or may not repeat in the fourth quarter.

Steve, I think, I think you covered the majority of it. When we take a look at the change in our top line guidance, right. Our guidance went up by about the midpoint of our range went up by about $15 million a good portion of that was specialty garments performance in the quarter. And we've talked at length about how their core or their quarterly performance is a little bit more unpredictable and can fluctuate from quarter-to-quarter but some of that did come from the benefit that we saw in our core laundry operations. Clearly that wasn't all or I guess the increase in our revenues wasn't completely attributable to our third quarter performance because we are expecting and anticipating that some of the benefit that we're seeing in the core will carry over to the fourth -- to a portion of that is related to the core and is permeating into the fourth. Our Specialty Garments performance expectations for the fourth really haven't changed. And then Steve spoke about the majority of the benefits that we saw during the quarter when we talked about the understaffing, when we talked about the adjustments that we made to the reserves that, sort of, benefited the quarter -- those broadly translated into our margin performance. Things like the beneficial tax rate that we had in the quarter, related to some of the discrete events, again, were captured in that third quarter and aren't necessarily anticipated or included in our assumptions that they're going to continue into the fourth. But some of the things that Steve talked about have influenced our expectations for the fourth, right, like he's mentioned the fact that our third quarter, we started to see our merchandise stamps return to a level that sort of were similar to pre pandemic. And eventually the expectation is that that merchandise over time, given the way that we account for will eventually start to normalize back to a normal percentage of revenues. Our healthcare claims cost during the quarter were higher. We had mentioned that we believe that there's, some pent up demand for that and that, sort of, influenced our expectations for the fourth quarter as well. So some of those dynamics are, sort of, informing, I guess, what you're seeing on the margin side, but some of those benefits that our third quarter benefited from, really were, sort of, captured in that quarter and aren't necessarily benefits, we would expect going forward.

Shane, are you able to, can you just give us a sense of the bad debt release? What's that benefit of the quarter or how much the understaffing or healthcare were? Just trying to get an order of magnitude. So we understand the impact in the quarter.

Yep.

That's when I speak about that in the past.

Yeah. Absolutely. Our bad debt -- or I guess the benefit that our quarter had related to our bad debt reserves is probably 40 to 50 basis points. As far as the understaffing, is a little bit more challenging to quantify the impact on the quarter, because obviously you're benefiting from the lower payrolls but those payrolls are providing you benefits and you're also incurring some costs related to overtime and temp labor, et cetera. But the benefit related to the -- the understaffing was probably a $1.5 to $2 million. Again, that's not ideal for us. That's not what we -- that's not what we, hope to have going forward, but financially at least we saw that that short-term benefit in the third.

That's helpful. And then, sorry, just one last question. You had some comments on, if you call it PPE, but some of this like -- put in with like the hand sanitizer things that I would think would start to be rolling off, or at least be starting to face tough comparison. And maybe it wasn't because you had a May quarter and the supply chain wasn't fully there in the beginning days of --of COVID last year. But it was just interesting to hear you guys saying that that was a benefit year-over-year. Does that as we move to the four Q to -- are some of these PPE benefits that you have, do they become headwinds? What is the current run rate on that saying or -- or do you think that it's flat to up on a year-over-year basis, I guess trying to understand that dynamic will be helpful?

Yeah. It's a good question. I mean, your comment about the supply chain, I think is correct from the third quarter last year. We weren't quite ramped up to where we want it to be. The biggest benefit to be honest in the current quarter was in the area of gloves as opposed to soap and sanitizer. There's been a shortage in that area. Prices are quite a bit higher for those products and we were in a pretty good position from an inventory perspective to go out and take -- take some advantage of that. And I think with the reopenings, you're seeing some people need some of that product. So as far as the fourth quarter goes, that's the magic question. I think how long will some of this blip last? I think we have some of it going through the fourth quarter and then moderating a little bit from the third quarter run rate. That's probably impacting our fourth quarter a little bit as well. I think the bigger question is you go into next year, what does that look like? Can we sustain -- I think we've invested in sales resources to sell into our existing accounts over the last couple of years. And we're hopeful that the experience of the pandemic will help us have some ongoing benefit in that area in terms of penetration with our customers. But I think as you look into the fourth quarter and next year more next year than the fourth quarter, there might be some tougher comps. But in the fourth quarter, you're probably still a little bit, getting a little bit of a benefit year-over-year, to be honest from some of those -- if what we saw in the third quarter continues and it has so far.

Thank you.

And our next question is from Andrew Steinerman, J.P. Morgan. Please go ahead.

Hi. I wanted to ask you about your preliminary cautious comments about margins for next year. I Just assume now that organic revenue growth is positive and getting more positive into the fourth, that there is a somewhat, an offsetting element of operating leverage. And so, my question is, assuming the economy continues move forward, do you feel like this is going to be a couple of quarters of margin drag that you're signalling good. Do you feel like from what you already know about kind of the cost element that -- it's going to be a whole year of margin drag? And then my second question is, do you think you might be the way you said it conflating inflation, which is obviously input cost inflation with that cost are just coming back more, travel more uniforms and it's not particularly inflation, it's discretionary costs coming back.

Yeah. It's an important question, Andrew. When we -- when you start to look at next year and we're not here to provide guidance for next year, but we made the comments for a reason. When we think about the different areas of costs, we're going to be dealing with looking into 2022, it really is in what I'd call three different areas. You have the area that you mentioned would call it the inflationary environment. Clearly, the cost and availability of labor is a challenge. Now, how long will it be a challenge? Is it a -- is it a surge that moderates, is it an ongoing challenge? I think it's something we're going to be having to deal with. We are dealing with it now, and it is going to cause costs to rise. And as costs rise, whether it's with labor energy fabric costs or any other inputs that are currently being impacted by call it the inflationary environment, we will work with our customers to pass along costs where we can. So, that's one category, you're right about the second category is being, sort of, this bounce back of costs. And that's why we made the comment particularly on merchandise, which is the largest piece. For six to eight months starting at the beginning of the pandemic, call it March, 2020, we started seeing a significant amount of lower needs for merchandise ads, not just from new accounts, but from replacement garments, which is the bulk of our merchandise requirements. Those as -- as you understand, how we amortize our merchandise, those caused our overall merchandise expense for 2021 to be quite a bit lower than our historical norm. We're starting to see that bounce back now could understand, as it bounces back, for example, this quarter is probably one of the -- almost the low point, because as you start to put in more, right that amortization starts to build again. So, over the course of 2021, we, -- I'm confident in saying, we will be experiencing higher merchandise amortization as a percentage of revenues. Hopefully in October, what will -- we'll be able to give you a better sense with three or four months more information as to what we think that looks like. But the caution here is to say that the merchandise amortization, we're experiencing today is over a hundred basis points lower than, sort of, historical levels. When do we get back to those historical levels? How does the energy sector intersect with that? How does sales intersect with that? There's a lot of factors, but we just wanted to highlight that that cost is running historically low and we fully expect it to normalize. Similarly with travel, which we obviously can control a little bit more. We are benefiting still from less travel, quite a bit less travel than, sort of, the pre-pandemic time. And like a lot of companies, we're looking at travel to say, where can we be more efficient? What have we learned during the pandemic that can help us manage travel costs more effectively? And there are ways, but we need to be out in front of our customers. There's travel that will come back. And then the third category of costs, which is, sort of, inherent in some of our comments as well, is our initiatives like the ABS deployment and some other things that we'll have going on in 2022. We will probably be more proactive about speaking about those costs and probably even giving you sort of an indication of adjusted operating margin as we go into 2022, and these costs continue to be more significant. So it is three discrete areas. I tried to mention all of them in our prepared remarks, because we do want to caution a little against, I think what you're talking about, which is the economy has recovered everything's back to normal. Well, our business has always benefited during slow times from a cost perspective. And during growth times, there can be margin challenges from things like energy, merchandise and others. This is even probably accentuated even more than that, because I'd say during the pandemic things like merchandise and energy and healthcare and travel were all things that were abnormally benefiting compared to say, the last recessionary cycle, where you didn't see that dynamic with healthcare, you didn't see that dynamic with travel. So it is a unique cycle that we're working towards. And that's why we're trying to provide that, that caution for 2022 and depending on how the economy recovers and the top line and all those other things, we'll -- we'll see where it shakes out. But we did want to provide that clarity.

Yeah. Could I -- can I just try one last follow-up on the same subject, when you look at those three buckets for 2022, which one seems the most sizeable of the three buckets you just described?

It's -- the most what? I missed the last word.

Size -- sizeable, the biggest, the biggest?

Sizeable.

The biggest headwind to margins. Yeah.

Well, it's a good question. I mean, merchandise is probably the biggest singular factor that will normalize, but it won't normalize overnight. So you're going to look at the first quarter of 2022, and you're going to say, well, merchandise, isn't so bad, but it's going to quickly ramp as we continue to put in higher levels of merchandise over time. I would say to be honest, Andrew, the bounce back of cost is probably the one to kind of most be cognizant of the inflationary environment something we're going to have to deal with. But as we try to look at pricing opportunities and work through that, that's -- that's more, it's a -- it's a, it's a sizeable challenge, but it's more business as normal, I would say. And then the investments or the investments, I don't think that's something that overly concerns me because its investments we're making -- its capital, we have to invest and we'll -- we'll let you know what those numbers are. So it's really that middle one that you'll have some bounce back that that we want to make sure people are aware of.

Got it. Thanks for the time. I got it.

Thank you.

Gentlemen, those are all the questions we have. I'll turn it back to you for closing remarks.

I'd like to thank everyone for joining us today to review our third quarter results. We look forward to speaking with you again in October, when we expect to be reporting our fourth quarter performance, as well as our full outlook for Fiscal 2022. Thank you and have a great day.

And ladies and gentlemen, that concludes our call for today. We thank you all for your participation. Have a great rest of your day. You may disconnect your line.