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UniFirst Corporation (NYSE:UNF)

F3Q10 (Qtr End 05/29/10) Earnings Call Transcript

June 30, 2010 10:00 am ET

Executives

Steve Sintros – VP, Finance and CFO

Ronald Croatti – Chairman, President and CEO

Analysts

Chris McGinnis – Sidoti & Company

Andrea Wirth – Robert W. Baird

William Lee – JP Morgan

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the third quarter earnings results 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) I would now like to turn the conference over to Steve Sintros, Chief Financial Officer. Please go ahead, sir.

Steve Sintros

Thank you and welcome to the UniFirst Corporation conference call to review our third quarter results for fiscal 2010 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 factors including, but not limited to, volatility in employment levels and general economic conditions; the continued availability of credit; the performance of acquisitions; fluctuations in the cost of materials, fuel, and labor; and the outcome of pending and future litigation and environmental matters. I refer you to our discussion of these points in our most recent filings with the Securities and Exchange Commission.

Now I will turn the call over to Ron Croatti for his comments.

Ronald Croatti

Thank you, Steve. I’d like to welcome all of you who are joining us for the review of UniFirst financial results for the third quarter of fiscal 2010. Steve will be covering the details in a few minutes, but let me start with a brief recap. Revenues for the third quarter were $261.2 million, a 3.6% increase compared with the same period of fiscal 2009, with all business operations contributing to the topline gain.

Our core laundry operations continued to drive overall company performance, achieving a revenue increase 1.8% over last year’s third quarter, but it was our Specialty Garments business that provides uniform and ancillary services for the nuclear cleanroom industry had a particular strong quarter with a 22% revenue increase as compared quarter-to-quarter basis last year to the Specialty group recording setting performance can be credited to a combination of existing account growth, including improved activities with the Canadian customers, safety supply sales, and positive results with the European operations.

Revenues from our First Aid business were also up, delivering a 6.6% increase over the same quarter in fiscal 2009. Although this segment’s Green Guard operation, which installs service and services first aid cabinets, continued to be hard hit by the recessionary environment. Its unique operation, which private labels had supplies over-the-counter medication for resale, continued to grow with retail market and was responsible for most of the segment’s improvement.

Net income for the quarter was $19.3 million, an 11% decrease when compared to the third quarter of fiscal 2009. However, net income year-to-date was in line with the same record-level period of last year. Our core laundry operations continued to stabilize during the quarter in the dramatic uniform wear loss we experienced throughout the recession. Although our uniform losses were still greater than they had in the third quarter, despite this negative metrics, our core laundries drove the company’s positive performance with new sales coming in ahead of the same period last year.

In our core business, we continued to focus on sales and service fundamentals, as well as productivity improvements, with the increased number of corporate training programs being delivered to more team partners through our new highly effective video conferencing network. Via this network, our management teams are also receiving more in-depth instructions in sales and service techniques, consistently becoming (inaudible) in both of these critical areas. All of our training efforts are designed to increase overall sales productivity, reinforce our consistently higher customer service levels, and provide clear career path opportunities for our team partners.

Several key measurements we used to track professional sales are now validating the efforts of our ramped up training efforts, including more strategic and more targeted selling by our teams, which has an increased overall sales productivity over last year. Unfortunately, our new accounts and customer retention pricing continue to be negatively impacted by competitive pressures and overly cautious business decision-makers. Our reps are countering by finding more prospects willing to make their uniform program choices based on overall value versus per wear line item costs.

In the service area, our customer retention rates have been climbing steadily each quarter of fiscal 2010, illustrating that our back-to-basics approach to servicing our customers, as we would like to be serviced, is having a measurable positive effect. And we are continuing to implement new customer routing technologies companywide. This provides us with significant return on our investment.

These programs direct our thousands of service delivery vehicles to consistently follow the most efficient geographic routing plans. Drive times are always minimized and never overloaded although allowing for more face-to-face times serving customers. Overall, we were pleased with the results during our first three quarters of 2010, but we continue to proceed with fiscal caution and strict companywide cost controls.

As we keep a close watch on national employment trends and consumer spending, unemployment levels have a direct relationship to demand for UniFirst products and services. And in the month of May, employment improved slightly in the US, dropping to 9.7% from 9.9%, while holding steady in Canada at 8.1%. The US improvement, however, was attributed to hiring 431,000 temporary federal census workers, suggesting the private employers still remaining reluctant to hire back laid off workers.

As far as spending goes, a Federal Reserve survey released in June found the economic activity improved across all US regions for the first time since the recession began in 2007. This was certainly good news for the economy. But the modest rate of growth suggests that consumers are still reluctant to resume the kind of spending needed for true market recovery. We also continue to see positive economic indicators within our customer base relating to our adds over reduction metrics.

As I mentioned earlier, a dramatic rate of sequential loss in uniform wearers and customers had plagued us throughout last year, continue to decrease on a week-to-week basis throughout the first three quarters of fiscal year although not yet returning to pre-recession levels. We remain hopeful that all these signs of market stabilization that we know will be a long road to also recover all the uniform wearers lost throughout 2008 and 2009, and for national business spending to normalize. Meanwhile, our ongoing recession recovery plan positions us to maximize our opportunity in today’s marketplace and to take best advantage of invigorated economy.

We are fully confident that we have the right people, the most efficient systems in place to ensure the long-term growth in returns always. We will accomplish this by providing our customer the most consistent, high quality service available. We will also continue maintaining a strong cash flow to allow for any competitive acquisitions that make sense for us. And I have said many times again, no matter what the economic conditions, consistently exceeding customer expectations will always be our top priority at UniFirst. We look forward to reporting our continuing progress in the quarter’s ahead. And now to fill you in on the financial detail, I’ll turn it back over to Steve Sintros, Chief Financial Officer.

Steve Sintros

Thank you, Ron. As usual, I’ll provide some additional insight to our operating results for the quarter, our overall balance sheet position, as well as our outlook for the remainder of the year. Revenues for the third quarter of fiscal 2010 were up 3.6% to $261.2 million compared to the previous year’s $252.1 million. Third quarter net income was $19.3 million or $0.98 per diluted common share, an 11% decrease from the third quarter of fiscal 2009 when net income was $21.7 million or $1.12 per diluted common share.

The company’s core laundry revenues in the third quarter increased 1.8% compared to the same period in fiscal 2009. However, core laundry revenues were down 1% when excluding the 1.4% benefit from acquisitions and a 1.4% benefit from a stronger Canadian dollar. The core laundry revenues increased slightly from the second quarter of fiscal 2010, and we continue to be encouraged by the further improvement in our adds versus reductions metric.

Core laundry operating income declined to $26.2 million in the third quarter of 2010 from $33.3 million for the same quarter last year. The operating margin also fell to 11.5% from 14.9% in the third quarter of fiscal 2009. The margin decline primarily relates to higher cost of revenues, including energy, payroll and merchandise costs.

Total energy cost for our core laundry operations as a percentage of revenues increased to 5.8% during the quarter from 4.9% in the third quarter of fiscal 2009. Payroll costs were also higher than the same quarter in 2009, primarily the result of January 1st salary increases. In addition, we continued to experience increased merchandise cost in terms of total dollars as well as a percentage of revenues.

Overall, merchandise amortization for the core laundries was higher than the second quarter of fiscal 2010 as well as the third quarter of 2009. As expected, the significant benefit that we realized over the last two years from the utilization of garments with feedback from laid off workers is beginning to turn. We continue to see an increase in garments that we are placing into service to support both our existing customer base as well as to support higher new sales levels compared to 2009.

Although the utilization of our used garment stock is an important aspect of maintaining our profitability, ensuring our customers are provided with high quality garments continues to be a top priority. Increased sales force headcount as well as the January 1st salary increase contribute to higher selling and administrative cost during the quarter compared to 2009.

Also, as we discussed in our previous quarter’s earnings calls, over the next six years, we will be recognizing non-cash stock compensation expense in conjunction with restricted stock awards granted to our Chief Executive Officer during April of this year. During the current quarter, we have recognized approximately $0.8 million of non-cash stock compensation expense related to these grants. And in our fourth fiscal quarter, we will recognize $1.2 million.

Also, as a reminder, during the third quarter of fiscal 2009, we incurred a $1.1 million charge related to certain environmental contingencies. Our results this quarter benefit from the absence of a similar charge when comparing them to the same period a year ago. Overall, the results of our core laundry operations for the quarter were in line with our expectations, as the margin decline coming off last year’s record highs was anticipated.

The company’s Specialty Garments segment increased its revenues $4.6 million or 22% compared to the third quarter of 2009. This increase in revenues was the result of certain US and Canadian reactor projects, continuing longer than expected. Project based work within this segment can be unpredictable with respect to the time and effort associated with completing reactor rebuild and refueling projects. The longer these projects take, the more uniforms in related processing our customers require to support these efforts.

In addition, this segment’s European operations had a solid quarter and continue to expand their customer base following the opening of a new laundry plant in the United Kingdom last year. As a result of this increase in revenues, operating income for this segment increased to $5.2 million from $3.0 million in the third quarter of 2009. We do want to caution that several of these reactor projects will not repeat in fiscal 2011. And therefore, we expect that this segment’s revenues and profits will decrease from the current fiscal year’s record results.

Third quarter revenues for our First Aid segment increased to $7.8 million, up 6.6% compared to the same quarter a year ago. Income from operations for this segment also increased $0.7 million in the quarter from $0.4 million in 2009. These stronger results were driven primarily by the segment’s wholesale [ph] distribution business. The van operations within this business, which install and service first aid cabinets, continued to be pressured by a difficult economy where customers are still hesitant to add back expenses that were cut during the last couple of years.

Net interest expense for the quarter was $1.7 million, down slightly from $1.8 million a year ago. Due to the weakening of the euro and the pound against the US dollar, we also recognized a $0.6 million currency loss during the quarter compared to a $0.8 million gain in 2009. The effective income tax rate for the quarter was 35%, down from 39.3% in the third quarter of 2009. The lower rate for the quarter was the result of reductions of tax contingency reserves due to statute expirations as required by FIN 48. We expect our income tax rate for the fourth quarter will normalize at approximately 39.5%.

Our balance sheet and overall financial position continue to be very strong. At the end of the third quarter, the company had $104.5 million of cash and cash equivalents on hand compared to $60.2 million at the end of our most recent fiscal year. Total debt outstanding remained constant at approximately $181 million, and total debt as a percentage of capital decreased to 20.8% from 22.5% at year-end.

Accounts receivable increased by $8.4 million or 8.6% from year-end. This increase is primarily due to increased billings in our Specialty Garments segment as well as sequential increases in our core laundry revenues, including the impact of the stronger Canadian dollar. Merchandise in service increased $9.8 million or 13.5% since the end of fiscal 2009. As discussed, we continue to see a rise in new garment additions needed to support our customer base and expect that this trend will continue over the remainder of fiscal 2010 and into fiscal 2011.

For the first nine months of fiscal 2010, we generated significant cash flows from operations totaling $99.8 million. Capital expenditures were $37.3 million for the first nine months of fiscal 2010, and we now expect that they will be approximately $50 million for the full fiscal year. During the first nine months of the year, free cash flows were primarily used to increase the company’s cash balances by $44.3 million as well as to fund $17.8 million in acquisitions.

We continue to evaluate acquisition targets based on our long-term strategic objectives as well as the appropriateness of their valuations. We have significant borrowing capacity under our existing line of credit and could clearly take on additional leverage. Based on our financial strength and ability to generate significant cash flows, we continue to be well positioned to take advantage of strategic opportunities as they arise.

Based on the stabilization of our core laundry revenues as well as the strong performance of our Specialty Garments segment, we are raising our previous revenues and earnings estimates for the full year. We currently project that our revenues for fiscal 2010 will be between $1.017 billion and $1.022 billion. We also project that our income per diluted common share for fiscal 2010 will be between $3.70 and $3.80.

We are very proud that the company’s record of always growing its full fiscal year revenues at least on an even work-week basis will likely remain intact despite enduring what some would call the worst recessing since the Great Depression. This achievement is a testament to the value of the services we provide, the resiliency of the company, and the ability of our employees to execute during difficult times.

We look forward to speaking with you all again in October to discuss our results of our fourth quarter as well as to provide our outlook for fiscal 2011. This completes our prepared remarks. And operator, we’d now be happy to take any questions that they may have.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Chris McGinnis from Sidoti & Company. Please proceed with your question.

Chris McGinnis – Sidoti & Company

Hi, good morning, guys.

Steve Sintros

Good morning.

Chris McGinnis – Sidoti & Company

I guess, just in thinking about the operating margin and how it is – obviously it was aided by the Specialty business this quarter. Just going forward, you talked about it declining. Can you think of directionally in the core laundry operations how much pressure you think still to come? Or do you think that’s – I guess we’re right now at 11.5, is kind of a run rate.

Steve Sintros

I think we will still have pressure going forward in the merchandise area. We’re starting to see some of it now. I think – without getting too specific, I think there could be another point of pressure there. And a lot of that really depends on where the revenue ends up for next year. With some of the pressure we’re seeing, it’s coming kind of regardless of the growth that we are achieving. It’s more the lack of used garments that we have available and an increase in the garments we’re placing in service. So I think if we can gain some momentum on the top line and the adds-reductions continue to improve, we can keep that de-leveraging to a minimum, but we still have some ways to go in the merchandise side.

Chris McGinnis – Sidoti & Company

All right. And then I guess just on the – on obviously the acquisition side, is anything opening up, maybe getting a little I guess prices coming down at all or is there any freeing up I guess in that kind of the market?

Ronald Croatti

This is Ron. We really haven’t seen anything significant to this point. We’ve talked – there is a lot of smaller guys out there we’re talking to, but nothing of a major size at this point.

Chris McGinnis – Sidoti & Company

I guess just to follow that, what’s the driving – I guess, what would be the motivating factor for them at this point if the economy starts to improve here?

Ronald Croatti

I think most of the time when we are dealing with people that are older and want to resolve their estate issues or family fighting over money. That really seems to be what’s driving it at this point.

Chris McGinnis – Sidoti & Company

Driving faster.

Steve Sintros

If their volumes can recover a little bit as well that make them more likely to sell. I think a lot of them didn’t want to sell when their volumes were at their lowest.

Chris McGinnis – Sidoti & Company

Right. All right. That’s what I was hoping. All right. I’ll step in the queue and then jump back once other people asked. Thank you.

Steve Sintros

Thanks.

Operator

(Operator instructions) The next question comes from the line of Andrea Wirth with Robert W. Baird. Please proceed with your question.

Andrea Wirth – Robert W. Baird

Good morning, gentlemen.

Steve Sintros

Good morning.

Andrea Wirth – Robert W. Baird

I’m wondering if you could just talk a little bit more about the Specialty Garments business and just how long we should at this point expect a little bit more elevated levels. I mean, essentially, are some of these projects in the US and Canada that have continued longer than expected also going to continue into the fiscal 4Q, or should we already kind of expect levels to drop off already starting next quarter?

Steve Sintros

I think typically the fourth quarter is one of their down quarters. Just from a volume perspective, there are less outages in that quarter. So if you look at kind of the historical trend, Q4 will clearly be down from Q3. I think from a comparative perspective, it may be a little better. Some of these projects probably will have a little carryover into Q4, but they are starting to wrap up. And that’s why we cautioned that 2011 comps will have a whole new batch of outages, but some of these special projects that caused the revenues to jump this year will clearly be over by that point.

Andrea Wirth – Robert W. Baird

Is there a way you could give us an idea of what kind of the run rate may look like once we get into fiscal 2011, especially with the UK starting to ramp a little bit more?

Steve Sintros

That’s probably fairly difficult for us at this point. We have yet to go through kind of the annual budgeting process that will walk through with that group where they really lay out the outages for us. So we’ll clearly have more insight to that next quarter. But just from a comparative standpoint, they have already cautioned us that overall full year fiscal revenues will likely be down somewhat next year. But to what extent, we’d be hesitant to say at this point.

Andrea Wirth – Robert W. Baird

Okay. Okay, fair enough. On the add-stops [ph], it sounds like they – is it fair to say that they just – they are still negative, but will continue to be less negative and that they have not quite yet turned positive? Is that correct?

Ronald Croatti

That’s correct.

Andrea Wirth – Robert W. Baird

Okay. Okay. And then in terms of how we think about the organic growth rate in the core laundry business, do we think we can start getting to positive organic growth already next quarter or is that a little bit optimistic just kind of given what we are seeing in the environment out there?

Steve Sintros

That might be a little optimistic, but we do expect that we will continue to narrow that gap and then as we move into next year, hopeful that we’re starting to show organic growth rates at the very latest, early next year.

Andrea Wirth – Robert W. Baird

Okay, okay. That’s fair enough. And then just trying to attack the merchandise questions just a little bit more, could you maybe tell us what the merchandise cost hit was this quarter versus last year?

Steve Sintros

From a percentage margin perspective or normal perspective?

Andrea Wirth – Robert W. Baird

Yes, yes. From a margin perspective, yes.

Steve Sintros

It was in the neighborhood of about 0.5%. It is still not – and that’s why we think there are still some left to come. I think we’ve said in the past few quarters that our merchandise costs, last year especially, were probably 1.5 to 2.0 points lower than kind of a historical level. And I’m not sure we’ll give all that back, but we clearly haven’t even really given back a full point compared to last year. And I think we’ll at least do that.

Andrea Wirth – Robert W. Baird

All right. I guess, even then in that perspective, I mean, sorry to play a little bit devil’s advocate, I guess – I mean, to me, it feels like maybe holding 11% margins maybe a little bit challenging. I guess, kind of tell me where I’m wrong on that perspective, especially given that it sounds like pricing in the industry is still pretty challenging.

Steve Sintros

I think that’s still our goal, but we don’t disagree that that could be challenging, given the merchandise and the environment. It really depends on how much momentum we can get from a topline perspective and to really move the revenues. But I think you are looking at it the right way.

Andrea Wirth – Robert W. Baird

Okay, okay. And then just a final question, can you give us an idea in terms of how much your sales force’s headcount is up at this point?

Ronald Croatti

We’re up about 6%.

Andrea Wirth – Robert W. Baird

Okay. Great. Thanks so much, guys. Great quarter.

Steve Sintros

Thank you.

Operator

(Operator instructions) The next question comes from William Lee with JP Morgan. Please proceed with your question. Mr. Lee, your line is open. Please proceed with your question.

William Lee – JP Morgan

Hi, gentlemen. Can you hear me now?

Steve Sintros

Yes.

William Lee – JP Morgan

Okay, great. When you look at add-stop improvement, can you help us understand if that additional uniforms there? Is that in clients or is that new service – new services, so existing clients that’s driving that improvement?

Steve Sintros

It’s primarily an improvement in the net wears at existing accounts. So it’s not solely an improvement from new products going into accounts like mats or mops. It is an improvement in the wearers. And again, it’s a less negative number at this point from a purely wear perspective.

William Lee – JP Morgan

Right. I see. Okay, great. And then if we look at the operating margins, operating margins improved 80 basis points sequentially. And can you just go through what were the large components of that driving the improvement? What were the pluses and what were the minuses in basis points?

Steve Sintros

From the second quarter, I don’t know that full analysis, but if you kind of go back and look at some of the items we highlight that are always higher in our second quarter, we have some annual fixed pay payouts and some things that are specific to the second quarter that the absence of those items in the third quarter was the largest part of the margin improvement. Some of that is offset by the stock compensation expense. We mentioned that was in the third quarter and not the second quarter. And we continue to have merchandise tick-up. So those are really the key items that caused that difference.

William Lee – JP Morgan

Right. I see. Okay, great. Well, thanks again.

Operator

There are no further questions at this time.

Ronald Croatti

We’d like to thank you all again for your interest in our company. We feel more and more confident these days that the worst is behind us with the recession, allowing us to refocus our primary efforts of sustaining long-term company growth and investment return by delivering the highest quality customer service in the industry. We look forward to talking to you next quarter when we will be reporting on our fourth quarter and our year-end performance. Thank you, and have a great day.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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