Earnings Call Transcript - UNF Q2 2021

Operator, Operator

Greetings and welcome to the UniFirst Corporation Second Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session. It is now my pleasure to turn the conference over to Steven Sintros, President and Chief Executive Officer. Please go ahead.

Steven Sintros, President and Chief Executive Officer

Thank you and good morning. I am 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 the UniFirst Corporation conference call to review our second quarter results for fiscal 2021. This call will be on a listen-only mode until we complete our prepared remarks, but first a brief disclaimer. This conference call may contain forward-looking statements that reflect the company’s current views with respect to future events and financial performance. These forward-looking statements are subject to certain risks and uncertainties. The words anticipate, optimistic, believe, estimate, expect, intend and similar expressions that indicate future events and trends identify forward-looking statements. Actual future results may differ materially from those anticipated depending on a variety of risk factors. For more information, please refer to the discussion of these risk factors in our most recent 10-K and 10-Q filings with the Securities and Exchange Commission. As I have the last couple of quarters, I want to start by saying that first and foremost our thoughts are for the safety and well-being of all those dealing with the impact of the COVID-19 pandemic. Our second quarter results continued to be impacted by the pandemic as well as severe winter storms in Texas and the surrounding states during February. Considering these challenges, we were pleased with the solid results for our quarter. I want to thank our team partners sincerely for the tremendous effort that they continue to put forth ensuring that they take care of each other and our customers during these challenging times. They truly continue to deliver in every way. Consolidated revenues for our second quarter were $449.8 million, down 3.2% from the prior year; and fully diluted earnings per share was $1.71, down 6% from the prior year. Shane will provide the details of our quarterly results shortly. Our second quarter began during a time where positive COVID-19 cases were surging, and there was strong potential for further economic shutdowns. Cases have sharply declined during the quarter from those peaks, and vaccinations have started to pick up creating more stability in our overall operating environment. That being said, economic activity remains somewhat stagnant, and we have yet to see significant recovery activities take hold. This is especially true in the energy dependent markets that we service which have also stabilized but have not yet begun to recover. We continue to focus on providing our valuable products and services to existing customers and selling new customers on the value that UniFirst can bring to their business. As we have discussed, the pandemic has clearly highlighted the essential nature of our products and services. We believe the need and demand for hygienically clean garments and work environments positions our company well to support the evolving economic landscape. We continue to position our sales resources to take advantage of the opportunities that exist in the market today and as the economy recovers. Although our new account sales have been solid during the first six months of the year and comparable to the first half of fiscal 2020, they are down from the record level set in fiscal 2019. The overall impact from COVID-19 as well as sharp declines in activity in the energy dependent markets that we service are contributing to those comparisons. This decline has been partially offset by increased sales to existing customers. On a positive note, we do expect stronger activity over the second half of the year and from a retention standpoint we are showing marked improvements over the first half of fiscal 2020. Although the trajectory of an eventual recovery is difficult to forecast, we do feel that the improved stability in the overall environment allows us enough comfort to share with you our outlook for the remainder of the year, which Shane will provide shortly. Vaccine optimism continues to be balanced by uncertainty as to when and how quickly the vaccine will create strong positive movement in the economy. Our solid balance sheet positions us to meet these ongoing challenges presented by the COVID-19 pandemic, while continuing to invest in growth and strengthen our business. As we have talked about over the last year or two, we continue to be focused on making good investments in our people, our infrastructure, and our technologies. All of these investments are designed to deliver solid long-term returns to UniFirst stakeholders and are integral components to our primary objective of being universally recognized as the best service provider in our industry. We continue to make good progress on these core initiatives such as our CRM systems project. We are pleased to report that we have successfully completed several pilot locations and have now officially moved into the deployment phase of the initiative. Our CRM deployment is a foundational change to our infrastructure that will allow for service improvements and efficiencies moving forward. We will continue to invest in our future over the next several years, including key investments in supply chain, other technology infrastructure, route efficiency, as well as our brand. We will provide additional details as we progress with some of these key initiatives in the quarters ahead. And with that, I'd like to turn the call over to Shane who will provide the details of our results for the second quarter.

Shane O'Connor, Executive Vice President and Chief Financial Officer

Thanks, Steve. As Steve mentioned, our second quarter of 2021's consolidated revenues were $449.8 million, down 3.2% from $464.6 million a year ago, and consolidated operating income decreased to $40.7 million from $44.1 million or 7.8%. Net income for the quarter decreased to $32.6 million or $1.71 per diluted share from $34.7 million or $1.82 per diluted share. Our effective tax rate in the quarter was 22.7% compared to 24.2% in the prior year, which favorably impacted the EPS comparison. As a reminder, our tax rate can move from period to period based on discrete events including excess tax benefits and deficiencies associated with employee share-based payments. Our Core Laundry operations revenues for the quarter were $398.2 million, down 3.4% from the second quarter of 2020. Core Laundry organic growth which adjusts for the estimated effect of acquisitions as well as fluctuations in the Canadian dollar was negative 3.6%. Throughout the quarter, our weekly revenues remained relatively stable as we did not experience any significant headwinds from states, provinces, municipalities, or our customers responding to the surge in positive COVID-19 case counts during the holiday period nor did we see any significant tailwind from the impact of the rollout of the COVID-19 vaccines. However, during the quarter, our top line performance was impacted by approximately $2 million from the effect of severe winter storms in Texas and the surrounding states on our operations as well as our customer locations. Core Laundry operating margin decreased to 8.9% for the quarter or $35.4 million from 9.3% in prior year or $38.4 million. The segment's profitability was negatively impacted by the decline in rental revenues on our cost structure as well as higher healthcare claims costs. In addition, the lost revenue and additional expense we incurred from the severe winter storms in Texas and the surrounding states reduced our operating income by approximately $2.6 million or $0.10 on EPS. These items were partially offset by lower merchandise and travel-related costs. As Steve discussed, throughout the pandemic, we have maintained our long-term perspective when managing the business, and as a result we continued to invest in our core initiatives including the further development and upcoming deployment of our CRM system. Energy costs increased to 4.2% of revenues in the second quarter of 2021, up from 4.1% in prior year. This increase was primarily due to additional utility expenses the company incurred related to higher demand during the severe winter storms in Texas and the surrounding states. Excluding those elevated expenses, energy costs would have been 3.9% of revenues as the benefit that we had been seeing over the last several quarters started to moderate with the price of fuel increasing nationally. Revenues from our Specialty Garments segment, which delivers specialized nuclear decontamination and cleanroom products and services decreased to $35.2 million from $36 million in prior year or 2.1%. This decrease was primarily due to lower activity in the U.S. and Canadian nuclear operations, which was partially offset by continued growth in the cleanroom business. Both periods discussed benefited from significant one-time direct sales, which contributed to strong top line performance in a quarter that is usually negatively impacted by seasonality. The segment's operating margin increased to 14.9% from 12.9%, primarily due to higher gross margin on its direct sales as well as lower travel-related costs. These items were partially offset by higher payroll costs as a percentage of revenues. As we've mentioned in the past, this segment's results can vary significantly from period-to-period due to seasonality and the timing of nuclear reactor outages and projects that require our specialized services. Our First Aid segment's revenues were $16.3 million, compared to $16.4 million in the prior year. However, the segment's operating profit was nominal compared to $1.1 million in the comparable period of 2020. This decrease is primarily due to reduced sales from the segment's higher margin wholesale business combined with continued investment in the company's initiative to expand its first aid van business into new geographies. We continue to maintain a solid balance sheet and financial position with no long-term debt and cash, cash equivalents and short-term investments totaling $509.6 million at the end of our second quarter of fiscal 2021. For the first half of fiscal 2021, capital expenditures totaled $66.9 million as we continue to invest in our future with new facility additions, expansions, updates and automation systems that will help us meet our long-term strategic objectives. As a reminder, CapEx spend is elevated primarily due to the purchase of a $14.1 million building in New York City in our first quarter of 2020, which will provide us a strategic location for a future service center. During the quarter, we capitalized $2.2 million related to our ongoing CRM project, which consisted of license fees, third-party consulting costs and capitalized internal labor costs. As of the end of our quarter, we had capitalized a total of $27.7 million related to our CRM project. At this time, we have started a deployment of this application to our numerous locations and anticipate this will continue through fiscal 2022 and into fiscal 2023. As a result, we will start to depreciate the system over a 10-year life in our third fiscal quarter of 2021 with depreciation in the second half of the year approximating $1.5 million to $2 million. Additional depreciation for new capabilities, like mobile handheld devices for our route drivers, will ramp to an estimated $6 to $7 million of additional depreciation expense per year. During the second quarter of fiscal 2021, we repurchased 12,200 shares of common stock for a total of $2.3 million under our previously announced stock repurchase program. As of February 27, 2021, the company had repurchased a total of 368,117 shares of common stock for $61.8 million under the program. At this time, we believe our ability to project our results has improved. And I would like to take this opportunity to provide an update on our outlook for fiscal 2021. We expect our fiscal 2021 revenues to be between $1.793 billion and $1.803 billion, which at the midpoint of the range assumes an organic growth rate in our Core Laundry operations of 3.5%. As a reminder, the prior year comparison for the second half of fiscal 2021 will be negatively impacted by a $20.1 million large direct sale to a health care customer that we recorded in our third fiscal quarter of 2020. Full year diluted earnings per share is expected to be between $7.30 and $7.65. This outlook assumes an operating margin in our Core Laundry operations for the second half of the year of 10.4%, and reflects additional expense we expect to incur related to the deployment of our CRM system of approximately $5 million. Just to be clear, this amount includes the depreciation expense that I mentioned earlier. This concludes our prepared remarks, and we would now be happy to answer any questions that you might have.

Operator, Operator

Thank you. Our first question comes from Andrew Wittmann of Baird. Please go ahead.

Andrew Wittmann, Analyst (Baird)

Excuse me, yes, thanks for taking my question, guys. Good morning. I wanted to talk a little bit on the top line trends. I heard you say in the quarter no headwinds, no tailwind, stable performance. March is in the books as of today, Steve, and with another month of vaccine in and people trying to get out a little bit more, are you seeing March pick up over the February levels? And can you just talk about what you saw this month as it relates to the second half, the 3.5% guidance that you just gave?

Steven Sintros, President and Chief Executive Officer

Sure. Andy, I would characterize March as a slight pickup from February. Seasonally, typically coming out of the winter months, we have said there is somewhat of a pickup anyway. So, I wouldn't say that we've seen any strong rebound from customer closures or reopenings. Talking to some of our team, there's still optimism looking forward, but we still haven't seen a lot of real activity through March. Obviously, February was a tough month with some of the storms as well. So, things were improved certainly from there, but from a COVID perspective, and we always obviously keep a close eye on the energy markets, there was no strong movement in March.

Andrew Wittmann, Analyst (Baird)

Are there any leading indicators that you have, or what are the leading indicators that you're looking at to give you some confidence? I mean, the second half revenue guidance, obviously, it comes against an easier compare and that's probably a big part of it. But what are the things that you're looking at that gives you confidence in that 3.5% outlook either positively or negatively? Maybe there are things that you're thinking could happen that aren’t baked in or maybe some of the areas of risk, if you could just kind of talk about some of those factors, that'd be helpful.

Steven Sintros, President and Chief Executive Officer

Sure. When we look at our revenue trends, compared to three months ago when we decided not to give guidance, I think the concerns back then were of additional shutdowns that might significantly impact the trends. With what we're seeing right now, we just have more confidence that those are less likely. Those could impact results if things were to shift. When you look at our growth metrics, I talked about new account sales. We’re seeing a little better momentum there as we look towards the second half of the year, retention has been pretty stable. Then we have a population of customers that we're staying in close contact with who are either shut down or significantly reduced services because of the environment. Those are the ones that we feel like we could see some pull forward in the second half of the year. I will say we haven't built a tremendous amount of that in, but I think any benefits that we may get from some of those customers at least offsets the risk that there could be some further bumps in the road and makes us confident that we should be able to at least maintain the status quo environment. And like you said, a lot of the growth that we're projecting over the second half of the year is really about better comps compared to the third and fourth quarter of last year.

Andrew Wittmann, Analyst (Baird)

Great. That's really helpful. I wanted to ask one other on the CRM. Your line died a little bit while you were talking about CRM, so could you go through that a little more so we all have clarity? I think I heard that you capitalized some costs, $2.2 million on the CRM in the quarter. I think I also heard that you're going to have $1.5 million to $2 million of depreciation in the second half of this year. I also heard numbers of $6 million to $7 million and then a $5 million number in guidance. Could you just go through the costs that you're incurring on CRM one more time for this year and on an annualized basis? And when you think you'll start realizing some of the savings from it as well?

Steven Sintros, President and Chief Executive Officer

Yes, and thanks for pointing that out, Andy, and apologies for the technical difficulty. During the quarter, we capitalized an additional $2.2 million related to the CRM project. At this point in time, we have capitalized a total of $27.7 million related to that project. Because we're now in the deployment phase, we're going to start depreciating that system with an estimated useful life of about 10 years. So, in the second half of the year, our expectation is that we will incur between $1.5 million and $2 million related to the depreciation of that system. Eventually, the depreciation of that system we expect to ramp to between $6 million and $7 million. A large part of that is going to be some of the additional hardware that we will install as we deploy our locations related to things like mobile handheld devices that we will put in the hands of our route drivers. The $5 million number that I quoted in the prepared remarks was the additional expense that we expect to incur related to the deployment of that system in the second half of the year. That $5 million includes the depreciation I mentioned earlier. Some of it is lower capitalizable labor that we have been capitalizing to the project which, as we move into deployment, will move through the P&L. We also expect additional costs related to travel and training as we deploy those locations.

Andrew Wittmann, Analyst (Baird)

Okay. That's helpful. If the second half of this year's incremental expense is $5 million, does that annualize to $10 million, meaning on fiscal '22 you could have another roughly $5 million incremental, assuming rates and deployment cadence are similar? Is it right to think that these costs will be with you for the next 18 months or so as you roll through to full deployment?

Shane O'Connor, Executive Vice President and Chief Financial Officer

Yes, that's the right way to think about it. We do expect that when fully rolling out the system, these costs could be in the $10 million range on an annualized basis. We will be ramping up the number of locations that we deploy over the remainder of the calendar year, and that experience will inform those amounts. As we move along, we will continue to update you on our expectations around those numbers.

Steven Sintros, President and Chief Executive Officer

And just to be clear, when we talked about that $10 million or so, that could be on top of the depreciation, right? So, the depreciation will come through and end up at $6 million to $7 million a year once fully ramped, driven in part by hardware purchases. The extra costs that aren't depreciation—travel, deployment teams, IT support—could be in the $10 million range on an annualized basis, with the bulk of that in 2022 and then it will bleed over.

Andrew Wittmann, Analyst (Baird)

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

Operator, Operator

Thank you. Our next question comes from Andrew Steinerman of J.P. Morgan. Please go ahead.

Andrew Steinerman, Analyst (J.P. Morgan)

Hi, Steve and Shane. You mentioned that you haven't seen recovery activity overall yet. I assume you mean sequentially. You also called out energy as a market that's stable. Are there any other end markets to call out that are either recovering, stable, or exceptional in any way? And could you give any other puts and takes we should think about for the Core operating margin being 10.4% in the second half of the year, not related to the CRM system—perhaps merchandise amortization or other items?

Steven Sintros, President and Chief Executive Officer

Very thorough question. On recovery, yes, we mean sequential improvements—customers reopening, etc. Regarding end markets beyond energy, we are seeing improved activity in certain health-care-related areas, such as dental offices and other healthcare applications that have become a larger part of our end market offerings during COVID in particular. There's some strength there. We are not as heavy in food, beverage, and hospitality, though you are seeing improvements in those sectors; they don't provide a large pull for us because we're not as concentrated there. For broader sectors like manufacturing or automotive, I'd characterize them as stable but nothing in particular providing a big pull right now. I'll let Shane address the margin specifics for the second half.

Shane O'Connor, Executive Vice President and Chief Financial Officer

When we look at margins for the second half and more broadly, a few items are impacting them. First, travel costs have been a benefit during the pandemic due to reduced travel. We expect that benefit to continue some as vaccines roll out, but we've learned to use remote tools effectively, so travel likely won't return to pre-pandemic levels. Second, health-care claims costs were elevated in the quarter as some discretionary surgeries and doctor's visits that were deferred are starting to occur; we anticipate these claims costs to remain elevated relative to the pandemic lows. Third, merchandise expense: over prior quarters we discussed a headwind because we were putting less merchandise into service, and amortization lags because merchandise is amortized over an average life of about 18 months. In the second quarter, we hit an inflection point where you're starting to see a benefit from merchandise, and we expect that benefit to continue into the second half of the year as the amount of merchandise put into service remains favorable compared to pre-pandemic levels. These items, along with the CRM expense we discussed earlier, are the primary drivers of the 10.4% operating margin assumption for Core Laundry in the second half.

Steven Sintros, President and Chief Executive Officer

One other thing I would add on energy: average gasoline prices have increased since last year, and that provides some headwind for the second half of the year compared to last year when prices were lower during parts of the pandemic. So you will see energy pick up as well.

Andrew Steinerman, Analyst (J.P. Morgan)

Got it. Thank you.

Operator, Operator

Thank you. The next question comes from John Cummings of Copeland Capital. Please go ahead.

John Cummings, Analyst (Copeland Capital)

Hi. Good morning. Thanks for taking the question. We wanted to get an update on your dividend philosophy. I'm trying to understand if you plan on increasing or evaluating the dividend on an annual basis? And then any comments you can make in terms of a target payout ratio or goal with the dividend? Also, one follow-up on the balance sheet: the cash creation continues to increase. At what point would you look to actively return some of that cash either via a special dividend or a buyback?

Shane O'Connor, Executive Vice President and Chief Financial Officer

Thanks for the question. Over the last few years we have had a couple of step-ups in the dividend. Our commentary has been that we will continue to evaluate the dividend on an annual basis and look at increases somewhat commensurate with increases in our free cash flow. Obviously, over the last year the pandemic made things bumpy, but as things smooth out we'll continue to look at it. We don't have a formal communicated policy in place right now, but you can count on us evaluating it annually. Regarding returning cash, we have had a buyback program in place and over the last quarter we've purchased a small amount of stock. We will continue to evaluate buybacks based on our comfort level around the trajectory of the business coming out of the pandemic as well as other plans for capital. We did slow purchases during the pandemic, and we'll continue to evaluate our approach going forward.

John Cummings, Analyst (Copeland Capital)

Thank you.

Operator, Operator

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

Steven Sintros, President and Chief Executive Officer

Great. I would like to thank everyone for joining us today to review our second quarter financial results. We look forward to speaking with you again in June when we expect to be reporting our third quarter performance. Thank you and have a great day.

Operator, Operator

This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.