UniFirst F1Q08 (Qtr End 11/24/07) Earnings Call Transcript

UniFirst Corp. (UNF)

F1Q08 Earnings Call

January 3, 2008 4:00 pm ET

Executives

Ronald D. Croatti - Chairman, Chief Executive Officer and President

Steve Sintros - Corporate Controller.

Analysts

David Long - William Blair

Ashwin Shirvaikar - Citigroup

Mike Schneider - Robert W. Baird

Kartik Mehta – FTN Midwest

Steve Balog - Cedar Creek Management

Presentation

Operator

Welcome to the UniFirst Corporation first quarter earnings results conference call. (Operator Instructions) Now I’d like to turn the conference over to Mr. Steve Sintros, Corporate Controller. Please go ahead, sir.

Steve Sintros

Thank you and welcome to UniFirst’s conference call to review our operating results for the first quarter of fiscal 2008 and to discuss our expectations going forward. My name is Steven Sintros and I am the Corporate Controller. 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.

Before I begin 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, believe, and other expressions that may 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 performance of acquisitions, fluctuations in thecost of materials, fuel and labor, economic and other developments associated with the ongoing war on terrorism, and the outcome of pending and future litigation in environmental matters.

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

Ronald D. Croatti

Thank you, Steve. I would like to welcome all of you for joining us for this review of our first quarter, a fiscal period that produced record revenues and profits for our company. Steve will cover the details in a few minutes, but let me start with a brief recap.

Revenues for the first quarter of fiscal 2008 were a record $247.3 million, an 11.2% increase over the $222.4 million in the same period a year ago. The major upside influence came from growth in our core laundries, with these operatings showing a 12.5% increase. Internal growth and price increases accounted for 8% of the laundry’s operational increase.

Our specialty garments and first aid business which showed solid revenue increases in last year’s first quarter generated smaller increases in this year’s first quarter. Specialty garments showed a 0.4% revenue increase as compared to the same period a year ago. The UniTech business suffers from the effects of certain utility customers rescheduling planned shut down periods which are times when our garment cleaning and decontamination services arein priority demand, as well as for some delayed revenue flow from new account installation. As we’ve noted several times inthe past, this business is somewhat lumpy and ithas a tendency to exhibit ups and downs. While showing reliable growth over the long term, despite a flat interval, we expect the unit to hit it’s revenue and profit targets for the full year.

Our first aid business showed a 2.1% revenue growth as compared to the same period a year ago. This was about what we anticipated based on organizational operational changes we are making. particularly in regards to our routes service operations. We are also in the process of shifting the new business development focus of our Medique business to put more concentration on the institutional and wholesale distribution markets and we are placing greater emphasis on securing third-party private labeling contracts for our private prestige packaging operation.

The combination of these initiatives with the tactical shifts it entailed have absorbed considerable time and energy during the quarter and resulted in some temporary dilution of sales numbers.

Net income for the quarter was a record $16.5 million, a 19.9% increase from the $13.7 million reported inthe first quarter last year. Earnings per diluted common share were $0.85 as compared to last year’s first quarter earnings per diluted common share of $0.71.

Thecore laundry business was the biggest contributor to profit growth with results benefiting from lower merchandise amortization as a percentage of revenue. Net income growth was also aided by lower effective tax rates inthe quarter as compared to the same period a year ago.

Our core laundry operations continue to drive the company’s growth and during the quarter we saw good results from both our professional sales and national accounts selling teams. Our floor reps in particular continue to benefit from the sales automation tools we’ve installed and experienced better contact and closing ratios as a result.

Even though we’ve held the line on pricing during the quarter, the number of new accounts closed was up as compared to the same period a year ago. Part of this was due to increased rep head count and lower turnover, but also resulted from smarter and more efficient selling. The average account size for new sales continues to trend up and our overall selling ratio held fairly steady, again reflecting efficiency improvements inthe selling process.

Weekly averages were up inall regions and we saw good balanced product in our new business. Facility service products continue to growin importance as a revenue category. This category growth is further aided by results from our route sales team which did a good job of adding the same items as new or expanding services at our current customers.

One thing we did seein the quarter, however, was an increase in reductions over our ad matrix for current accounts, indicating that we’re starting to experience some softening in employment and usage at current accounts. While this doesn’t necessarily raise a caution flag for the quarters ahead, it does support the fact that the overall economic conditions have slipped since our last quarterly report, and that simply means that there are uncertain times ahead which call for constant monitoring and careful management.

Most of the experts don’t believe a recession is likely. The consensus does point to economic growth of only about 2% for 2008. That means the softening trend in the private sector jobs is likely to continue. The latest report from the Bureau of Labor Statistics shows November unemployment unchanged at 4.7% but with slow economic growth and rising producer pricing, plus the ongoing triple whammy of higher oil prices, lack of credit availability and slumping housing prices affecting consumers, we think both business and consumer confidence is likely to slip further. That means that maintaining our first quarter revenue growth for the balance of the year may be a difficult task.

Still, difficult conditions are nothing new to us and we feel that all our business units are positioned to sustain momentum, even in sluggish markets. So barring a serious further deterioration of economic conditions, we remain optimistic that we can stay on track towards achieving our previous supply guidance targets. In that spirit, we look forward to the challenges the year will present and to being able to report our progress to you each quarter ahead.

Now to fill you in on our financial details, I’ll turn it back over to Steve.

Steve Sintros

Thanks, Ron. As Ron discussed, we had a very strong start to fiscal 2008. Consolidated revenues for the first quarter of 2008 were a record $247.3 million, an 11.2% increase over the first quarter of 2007. First quarter net income was $16.5 million or $0.85 per diluted common share compared to the first quarter of fiscal 2007 where net income was $13.7 million or $0.71 per diluted common share.

The company’s performance was primarily driven by strong results for our core laundry operations which includes our U.S. and Canadian rental and cleaning business, our garment manufacturing business, and our distributions and corporate operations.

Income from operations from our core laundry operations grew 26.1% from $22 million in the first quarter of 2007 to $27.7 million in 2008. As a percentage of revenues, income from operations from the core laundry increased from 11.1% in the first quarter of 2007 to 12.5% in the first quarter of 2008. The growth and profits in the core laundry operations was primarily the result of strong revenue growth. Revenues from the core laundry operations increased 12.5% in the first quarter of 2008. 8% of the growth was due to organic growth and price increases while 3.4% was due to acquisitions, primarily the acquisition of Western Uniform and Towel Service, which was completed in September 2007. Fluctuations in the Canadian dollar exchange rate also accounted for 1.1% of the overall growth of the core laundry operation.

The increased profit margin of the core laundry operations primarily relates to lower merchandise cost as a percentage of revenues. In addition, production and administrative payroll costs decreased as a percentage of revenues compared to the first quarter of fiscal 2007. These positive cost comparisons were partially offset by higher selling and healthcare related costs.

The first quarter revenues of our specialty garment business were up slightly from $17.2 million to $17.3 million; however, the income from operations of this segment declined from $2.9 to $2.1 million. This decline is due to higher merchandise costs associated with the number of new customer installations.

In addition, the company’s European operations were affected by a delay in a funding for a large decommissioning project. Certain other costs were also higher than in the higher period, but nothing that we view as an indicator of longer term profitability concern and we’re still optimistic that the full year performance of this operating segment will contribute to both our overall revenue and profit growth.

For the first quarter of fiscal 2008, revenues from our first aid segment increased 2.1% from $7.7 million to $7.9 million. The income from operations for this segment, however, decreased from $0.6 million in 2007 to breakeven in fiscal 2008. As Ron discussed, this segment is making operational and organizational changes which resulted in some additional costs and minor sales disruptions in the near term.

In addition, this segment’s profitability decreased due to some inventory write offs as well as the sales mix that resulted in lower margin sales compared to the first quarter of fiscal 2007. We continue to believe that over the long term, this segment will be a valuable contributor to the company’s overall growth.

Consolidated depreciation and amortization was 5.2% of revenues for the first quarters of both fiscal 2008 and 2007 and net interest expense increased from $2.9 million in the first quarter of fiscal 2007 to $3 million in fiscal 2008 but was down slightly as a percentage of revenues.

The provision for income taxes decreased from 39.3% in the first quarter of 2007 to 38.5% in fiscal 2008. On an ongoing basis we expect our income tax rate will be approximately 38.5% for the balance of fiscal 2008.

The financial position of UniFirst continues to be very strong. Merchandise and service increased from $86.1 million at August of 2007 to $93 million at November of 2007. This increase was primarily due to the acquisition of Western Uniform as well as increases in safety merchandise and service, primarily flame resistant garments which continues to be a high growth market for us.

Net property and equipment increased from $334.1 million at August of 2007 to $341.1 million at November of 2007 due to capital spending in the first quarter of $14.8 million. We now anticipate capital spending will be approximately $55 million in fiscal 2008.

We also expended $36.6 million on acquisitions during the first quarter of fiscal 2008, the largest being Western Uniform which had its headquarters in Wichita, Kansas and serves customers throughout Kansas as well as parts of Oklahoma from a total of seven facilities. We continue to work towards integrating Western Uniform’s locations into UniFirst’s systems and processes. As always, UniFirst will continue to aggressively pursue other acquisitions that we believe will enhance our operation.

Total debt increased from $206 million at August of 2007 to $234.5 million at November of 2007. Total debt as a percentage of capital also increased to 31.2% at November 2007 from 29.3% at August of 2007. These increases were primarily due to the acquisition of Western Uniform.

Looking ahead, despite uncertain economic conditions, we feel the remainder of 2008 will produce solid results for UniFirst. In our October call we communicated that our preliminary guidance for fiscal 2008 was that revenues will be between $980 million and $990 million and that income per diluted common share will be between $2.60 and $2.70. At this time, our guidance for the year remains unchanged.

We would like again to call your attention to the fact that fiscal 2008 will be a 53 week year and these projections include an extra week of revenues and profits compared to fiscal 2007. This extra week will fall in the company’s second fiscal quarter.

This concludes our prepared remarks and we will now be pleased to answer any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of David Lin with William Blair. Please go ahead.

David Lin - William Blair

Can you provide a little bit more color on the 140 basis point year over year gain inthe laundry operating margins? How much ofit came from the reductions in merchandise amortization, how much is coming from automation improvements atthe Kentucky plant, the rollout of handhelds, and how much can we expect this to continue throughout the balance of the fiscal year? Are we eventually going tosee the merchandise amortization reductions start to dissipate a little bit?

Steve Sintros

I think the bulk of that improvement was from the merchandise cost. There were some benefits with respect to production, payroll, and administrative payroll. Again, I think your reference is a good one to some of the automation. Butthe bulk ofit was from the merchandise. Some of this trend, I think we would expect will start to turn at some point during the year. At what point, it’s unclear. With the strong growth that we have, it is inevitable that garments will be going into service and that will start to ratchet back up again and that’s how things have gone over the last several years. It trends up and down and we’re at a good point right now.

I don’t think it’ll allgo away during the year. That really takes time for itto happen, so we probably maintained some of that benefit, but to what extent it’s tough to put our finger on. In addition, we anticipate that the fuel will become a little bit more of a factor as the year goes on. It really didn’t hurt us too much in the first quarter given our growth but we expect that to continue to be an uphill battle as the year goes on.

David Lin - William Blair

What is energy asa percent of revenues now, since you brought it up?

Steve Sintros

The fuel and natural gas together Is a little bit under 4%, David.

David Lin - William Blair

In the first quarter?

Steve Sintros

In the first quarter.

David Lin - William Blair

You guys mentioned that you’re still expecting inthe specialty garments division to hit your targets in fiscal 08. Does that mean that you expect margins in specialty garments to be higher than the 7.6% achieved in fiscal 2007?

Steve Sintros

I think it would have to be for the remainder of the year to get to the point where we can obviously beat last year’s numbers. Some of the things that happened inthe first quarter were some delay of certain work and I think certain one-time costs that we don’t expect to be a trend so our management there is pretty confident that they can meet their budget goals. I don’t think we’re quite as confident as they are but we still think that they can meet and beat their overall numbers from last year. I don’t know, Ron, if you want to add anything.

Ronald D. Croatti

I think that’s totally right. I think it centers back into the UK, their large decommissioning project started slightly and then the funding was held back and we expect that funding to come through and that revenue will pick us up and improve that margin we’re doing in Europe.

David Lin - William Blair

Ron, you mentioned the UK. Are there any new developments with establishing a plant there?

Ronald D. Croatti

We arein the process of working on it. We’re inthe permitting process.

David Lin - William Blair

Finally, I was a little surprised that you didn’t raise your guidance at all. Is there any particular quarter that you’re expecting a little bit more weakness than was originally thought?

Ronald D. Croatti

Normally our second quarter is our weakest quarter. The UniTech division generally loses money during that quarter and I think I tried to mention it in my comments. We’re seeing that shrinkage of our warehouse increasing and that’s a concern for us. We just have to sell that much more to try to make that up. We’re cautious on that side.

David Lin - William Blair

You were a little cautious last quarter but you seemed to power through itin the first quarter.

Ronald D. Croatti

We powered through it. Exactly what happened. We powered through it with a couple of good sales.

Operator

Our next question comes from the line of Ashwin Shirvaikar - Citigroup. Please go ahead.

Ashwin Shirvaikar - Citigroup

Hi. Thanks for taking my question and congratulations on a fabulous quarter.

Steve Sintros

Thanks Ashwin.

Ashwin Shirvaikar - Citigroup

Does your CapEx include the proposed UK plant for UniTech that you talked about?

Ronald D. Croatti

Yes it does.

Ashwin Shirvaikar - Citigroup

So you do expect that to happen this fiscal year.

Ronald D. Croatti

We hope so.

Ashwin Shirvaikar - Citigroup

The new client in specialties, was that allthe decommissioning project basically or is that thenew contract with continental Europe as well?

Ronald D. Croatti

It’s a combination of three things. It’s a combination of the decommissioning and cleanup project atUK, it’s getting more reactor sites which we addressed inthe UK with British nuclear fuels, and we’re hoping that we can pick up a small contract once again inFrance. That’s what the boys are telling us why they’re still optimistic.

Ashwin Shirvaikar - Citigroup

My last question is with regard to the first aid business. When do you expect the reorganization to be complete?

Ronald D. Croatti

I think we’ve taken the reorganization and moving the people around – it is pretty much done. It will be done by the end of the month. It’s developing the sales team and changing the concept of the way they were selling to getthe growth going that we’d like to get going and that will take a little longer. That’s going to take another six months at least.

Ashwin Shirvaikar - Citigroup

Okay. So another six months of that and once that takes off, if that happens, what kind of margins should we expect?

Ronald D. Croatti

I think we should expect the growth to get near that 8% to 10% range and we would expect the margins to return to where they were. Maybe even a little better than where they were.

Operator

Our next question comes from the line of Mike Schneider with Robert W. Baird. Please go ahead.

Mike Schneider - Robert W. Baird

Happy New Year, guys.

Ronald D. Croatti

Happy New Year, Mike.

Mike Schneider - Robert W. Baird

Ron, maybe you could just go back to a comment that you said a couple nice wins helped you power through the deterioration during the quarter. By that did you mean you signed or installed a couple big national accounts this quarter?

Ronald D. Croatti

We have. We got them installed. We basically inked them last quarter but we were able to take advantage of the revenue build up this particular quarter.

Mike Schneider - Robert W. Baird

Were they fully installed this quarter or will there be some incremental gain next quarter?

Ronald D. Croatti

They were pretty much fully installed this quarter.

Mike Schneider - Robert W. Baird

National accounts then as a percent of revenue now? It must be running at 8% or 9%?

Ronald D. Croatti

You got it. You’re right there at about 8.5% range.

Mike Schneider - Robert W. Baird

Add stops to go back to that, the monthly trend, did it actually deteriorate through the quarter?

Ronald D. Croatti

It deteriorated through the quarter, Mike. I know you follow those numbers. We have seen a deterioration greater each month.

Mike Schneider - Robert W. Baird

How about since November? What have you seen through December?

Ronald D. Croatti

December was not good. This week is probably going to bethe worst week of the year for us. People don’t lay off the last two weeks of December and we expect a pretty good sized hit this week. It’s a concern of ours. Again, going back to our business, we do a lot of street business, and a lot of that street business was related to the housing business, the air conditioner, the plumber, and so forth. They’re not replacing these people. That’s what we’re seeing, although our Region 4, our Florida region, is the hardest hit. That’s pretty unusual because usually that builds up this time of year with all the snowbirds going down there and that region’s hard hit for some reason.

Mike Schneider - Robert W. Baird

So then in terms of your initiatives on the sales force, it sounds like things are unfolding as you would have hoped in terms of head count increases, turnover being down etc. I guess I’m still perplexed as to how the organic growth, that 8%, was able to overcome the deterioration in the add stops. I presume new account sales must be running near 20% this quarter up from 15 last quarter?

Ronald D. Croatti

Not quite. We put through a pretty good price increase too probably near the end of September to compensate for the increase we saw coming inthe fuel and oil so we made a pretty heavy adjustment in that and that helped us along and as you well know, the sales organization has reported directly to me and I’ve been pounding sales like no tomorrow and we’re getting the results.

Mike Schneider - Robert W. Baird

Pricing now, historically the industry I guess ran somewhere just over 2% inthe last three to five years have been running at 1%. Doyou think you can reachieve that 2% to 3% rate?

Ronald D. Croatti

We could tell you we did better than 2% for the quarter.

Mike Schneider - Robert W. Baird

Okay and then the selling ratio, you mentioned inthe release that selling costs were higher but yet you made the comment in your prepared remarks that the selling ratio held flat during the quarter. Can you reconcile those? I imagine they’re different numbers.

Ronald D. Croatti

Well I think we look atit two different ways. We look atit as a percentage of sales and then we look atit as a multiple of new business that we write. I think you’ve heard me mention this numerous times. What our selling cost is and what our dressing cost is and when we put those two together we use that to basically look at our acquisition cost. We think what we’re saying is that as a percentage of revenue the selling cost has gone up but because our head count has gone up, reps under management plus the better sales performance that we have been getting out of our people has lowered the ratio so for every $1 of business that we’re writing, all-in is down slightly.

Mike Schneider - Robert W. Baird

On the merchandise costs, it’s been my experience, I’ve been following these companies for almost a decade now, that is if organic growth is accelerating, the merchandise costs as a percent of sales accelerates as well and then vice versa, you get relief when organic growth is slowing down inthe laundry division. That didn’t happen this quarter but we’ve seen it for the last several quarters that merchandise has been favorable for you because the organic growth rate has been decelerating. This quarter it accelerated and yet it was still a boost. Is there something unusual about the national accounts that were rolled out this quarter? Is there something unusual about the mix?

Ronald D. Croatti

No, not really. I think as long as you keep writing more and more new business the amortization rates can stay in line but when you get less new business coming inthe door that amortization rate climbs.

Steve Sintros

I think there’s a little bit of a lag as well, Mike, and I think that’s partially why with our guidance we’re being a little cautious because like you said, we had a good quarter writing new business and we don’t expect that that margin benefit for the merchandise is going to be there all year, especially to the extent that it was.

Mike Schneider - Robert W. Baird

Okay. That’s helpful. That’s all I’ve got for now. Thank you guys and great quarter again.

Steve Sintros

Thanks Mike.

Ronald D. Croatti

I guess I should add you guys are probably wondering where John is. Mr. Bartlett is on vacation inEurope and he will be returning next week.

Operator

(Operator Instructions) We have a follow up question from the line of Mr. Mike Schneider. Please go ahead.

Mike Schneider - Robert W. Baird

Ron, just one final one. You mentioned that facility service products are growing in importance as a percent of revenue. Do you have some of those breakouts now given that the division has been growing?

Ronald D. Croatti

I don’t think we’ve ever put those out, Mike.

Mike Schneider - Robert W. Baird

All right. Do you care to give us a ballpark?

Ronald D. Croatti

You know as a percentage of revenue I think we’re still strongest inthe garment. We’re over 60% garment.

Mike Schneider - Robert W. Baird

Okay. Thank you again.

Operator

Our next question comes from the line of Kartik Mehta – FTN Midwest. Please go ahead.

Kartik Mehta – FTN Midwest

You talked a little bit about the economy in Florida slowing and you talked about maybe the add stops weakening. Is itall related to housing or have you seen other sectors slow as well that is having an impact on that?

Ronald D. Croatti

I really can’t qualify it. All I can tell you is some of the other companies have a larger national account than we do and maybe it’s more automobile related and maybe they’re not seeing it. Again, we’re the street business company. We doa lot of business with the plumbers, theair conditioning guys, the electricians, and so forth down the line and we see that shrinkage happening in there.

I think the housing market in theFlorida area, the trades down there are pretty slow. We don’t do much restaurant business. Some of our competitors do. We didn’t get that pick up that we normally get when the snowbirds go to Florida. We actually had shrinkage down there this year where normally we geta pick up.

Kartik Mehta – FTN Midwest

Ron, the other thing you mentioned that I found interesting was you said you were able to push a pretty decent price increase through. Is this just a normal price increase or was this because gas prices are going up, energy prices are going up?

Ronald D. Croatti

I think we pushed something through because we saw stuff coming, gas going up, and we wanted to get ahead of the curve.

Kartik Mehta – FTN Midwest

You would think in this environment no attrition as a result or normal attrition? Nothing out ofthe ordinary?

Ronald D. Croatti

So far it’s been normal. But these things take time to react. To this point I’d sayit ‘s normal.

Kartik Mehta – FTN Midwest

Thank you very much.

Ronald D. Croatti

All right.

Operator

Our next question comes from the line of Steve Balog with Cedar Creek Management. Please go ahead.

Steve Balog - Cedar Creek Management

On that last point, I was curious about this price increase and what push back or loss of clients you saw on that. Does that show up right away when you go see somebody or does it take them a while, a couple of months for the contract to roll out and for them to look around for another vendor? So when might we see the ripple effect from that?

Ronald D. Croatti

I think it’s basically a ripple effect. We basically follow our rental agreements. Our rental agreements are worded so that we can put more specialty charges on I guess you would call it, and we’ve implemented a higher specialty charge to anticipate the fuel going up which it has, along with our normal price increases.

Steve Sintros

But also to answer your question, I think it’s hardest hit as far as customer push back right away but there is a lag on it and we will seethe effects of that over the next quarter or two, but at a reduced rate.

Steve Balog - Cedar Creek Management

Are these special charges unusual for you all? I was under the impression that one of your strategies was a simple bill, not a lot of nickel and diming on stuff.

Ronald D. Croatti

Well, our basic strategy is a simple bill, but we anticipate gasoline going at $3.50 a gallon and our natural gas costs keep raising. We had to make amove and sobe it, really.

Steve Balog - Cedar Creek Management

Do you see anything from competitors? Are they following and everybody breathing a sigh of relief that somebody took the first step? Or actually were you the first step or are you the second guy? What’s the competition look like?

Ronald D. Croatti

I really can’t answer that.

Operator

There are no further questions at this time. I’ll turn the call back to you, sir.

Ronald D. Croatti

Very good. Well, I certainly appreciate you following the company and the interest in the company and we look forward to talking to you next quarter and we are confident that we will hit our numbers for the year. As we keep moving along we will keep the sales coming through the door and hopefully we can overcome the shrinkage problem that the country is experiencing with the economy. Thank you much.

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