UniFirst Corporation F2Q08 (Qtr End 3/1/08) Earnings Call Transcript

Apr. 2.08 | About: Unifirst Corporation (UNF)

UniFirst Corporation (NYSE:UNF)

F2Q08 Earnings Call

April 2, 2008 4:00 pm ET

Executives

John B. Bartlett - Chief Financial Officer, Senior Vice President

Ronald D. Croatti - Chairman of the Board, President, Chief Executive Officer

Steven S. Sintros - Corporate Controller

Analysts

Ashwin Shirvaikar - Citigroup

Michael Schneider - Robert W. Baird

Operator

Ladies and gentlemen, thank you for standing by and welcome to the second quarter earnings results conference call. (Operator Instructions) I would now like to turn the conference call over to John Bartlett, Senior Vice President, UniFirst Corporation. Please proceed, sir.

John B. Bartlett

Thank you and welcome to UniFirst's conference call to review our second quarter operating results for the fiscal 2008 year and to discuss our expectations going forward. My name is John Bartlett and I am the Chief Financial Officer. Joining is me Ronald Croatti, UniFirst's President and CEO, and Steve Sintros, our Corporate Controller. This call will be on a listen-only mode until we complete our prepared remarks.

Today we released the results for the second quarter and first half of fiscal 2008, which ended on March 1, 2008. Our net income for the second quarter increased almost 120% from the amount earned in the second quarter of last year. Although these results benefited because this year’s second quarter had 14 weeks versus 13 weeks last year, and the fact that last year’s quarter was impacted by non-recurring charges, the 2008 increase was very significant.

The increase is primarily due to improved performance from our core laundry operation and in simple terms resulted from the fact that our strong revenue growth was accompanied by tight cost controls, which increased our operating margin from 7.1% in the second quarter of fiscal 2007 to 11% this year. We are pleased that our focus to increase our operating margins is yielding results.

Now, before I turn the call over to Ron Croatti and Steven Sintros for more details, 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 expression 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 performance of acquisitions, fluctuations in the cost of materials, fuel, and labor, economic and other developments associated with the ongoing war on terrorism, and the outcome of pending and future litigation and environmental matters.

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

Ronald D. Croatti

Thank you, John. I would like to welcome all of you for joining us for this review of our second quarter and the first half results of fiscal 2008. Steve will get into the financial details in a few minutes but let me start with a brief recap.

We are excited to report our best second quarter and first half performance ever in revenue and profits. Revenues for the quarter were a record $270.3 million and for the first half, they were a record $517.5 million. This represents a 21.6% increase for the quarter compared to $222.4 million in the second quarter of last year, and a 16.4% increase for the first half compared to the $444.7 million posted in the first half of 2007. All business units contributed to these revenue increases, with the majority of the -- continuing to come from our core laundry operations.

Net income for the second quarter was the best ever -- $15.3 million, 120% increase from the $6.9 million in the second quarter of fiscal 2007. Net income for the first six months of fiscal 2008 was a record $31.8 million, a 53.4% increase over the $20.7 million reported in the comparable period last year.

U.S. laundry operations showed solid profit increases, both for the quarter and for the year to date, as did the Canadian laundries, our specialty garment business, and our first aid and safety business.

Profits benefited from both lower merchandise cost and lower payroll cost as a percent of total revenue, and the fact that we recorded an additional week’s results for both the quarter and the half, 14-weeks in the second fiscal quarter this year as compared to 13 weeks last year, and 27 weeks in the first half of this year as compared to 26 weeks last year, had an obvious positive impact on both revenues and profit lines.

Despite the general economic deterioration, our sales results have held up well. Professional sales reps for basic rental service were in the high single digits ahead of last year’s performance at the same time.

Sales turnover continued to trend slightly downward and overall rep work weeks were up. Selling expenses as a percent of revenue were up slightly but new business pricing as measured in merchandise pay back weeks showed little change. This was somewhat of a surprise in light of the continued strong competition and with many business buyers showing increased hesitancy about long-term purchase commitments.

Sales promotions to our current customers delivered revenue increases over the previous year and our national account sales remained just about on budget. Naturally, we are pleased with the results we produced for the second quarter and the first half, but we’ve also seen enough uncertainty in our primary markets that we are being careful about predicting anything other than a real challenge over the last six months of the fiscal year.

Both our lost accounts and our reductions of our ad metrics have been moving up and with the U.S. economy showing clear signs of sinking lower, and with significant weakness expected in several industry sectors through the end of calendar 2008, there’s plenty of reason for caution.

Both of the institute for supply management indexes, manufacturing and non-manufacturing, have sunk below 50% mark, which indicates sector contraction. Eight non-manufacturing industries reported growth in February, while nine reported contraction. On the manufacturing side, seven industries reported growth and an equal number reported contraction. The combination of the credit crunch, unprecedented slump in the housing market is having a significant trickle down effect across a number of industry groups, and just as it took some time for this negative momentum to build, we expect it will take at least as long for the real signs of recovery to appear.

Even though February unemployment remained essentially unchanged at 4.8, we saw losses of 63,000 total jobs with 23,000 in the private sector, and a prediction for another 50,000 jobs to go away in March and the unemployment rate to ratchet up to 5%. Even the usually optimistic fed chairman said today that unemployment rates should move higher in the coming months.

Regardless of what happens, if job losses continue and total unemployment rises, we will feel the pinch right along with everyone else. As we noted, our wearer reduction numbers are already up on a year-to-year basis. We expect this trend to continue at least for the next two quarters. That, coupled with the likelihood of a more difficult sales environment, will make sustaining our first half increases very difficult. Consequently, we believe the most likely scenario is a slowdown in revenue growth coupled with increased pressure that will impact profits.

While oil prices are at unprecedented levels, our fuel costs have never been higher and some of the extra expenses won’t be recovered via pass through to customers. Additionally, our raw materials have an oil-based component -- certain synthetic fibers, as an example, are also expected to increase in prices. This combination will continually impact merchandise and delivery cost for some time to come and that in turn will result in drag on the bottom line. Not a pleasant perspective but one we are reconciled to and one we will be taking all reasonable actions to mitigate.

We’ve had a very good start of the year, thanks primarily to good selling, excellent customer service performance, and the exercise of tight operation controls at all levels. We don’t plan to change any of that in the second half so while we expect conditions to be less than favorable to maintaining our current performance track, you can be sure that our team partners will be working hard to deal with the challenges and will be focused on making this another record year for our company.

Now, to fill you in on the financial details for the quarter and the first half, I would like to turn it over to Steven Sintros.

Steven S. Sintros

Thanks, Ron. As Ron and John discussed, we were happy to report revenues and profits that represent the best results for the second quarter and first half of any year in the company’s history. Revenues were $270.3 million and $517.5 million for the second quarter and first six months of 2008, which represent increases of 21.6% and 16.4% respectively over the comparable fiscal 2007 period. Second quarter net income increased 119.6% to $15.3 million, or $0.79 per diluted common share from last year’s second quarter net income of $7 million, or $0.36 per diluted common share.

Net income for the first six months increased 53.4% to $31.8 million, or $1.64 per diluted common share, from $20.7 million or $1.07 per diluted common share in 2007. As Ron mentioned, both the second quarter and six-month periods of fiscal 2008 include an extra week compared to fiscal 2007, as this is a 53-week year for the company. The extra week accounted for revenue growth of approximately 8.9% and 4.4% compared to the second quarter and first six months of fiscal 2007 respectively.

As a reminder, the company’s second quarter and six-month earnings in fiscal 2007 were also affected by severance expense, as well as adjustments made to the company’s environmental reserve that combine to decrease the company’s income from operations and net income by approximately $2.3 million and $1.4 million respectively. Without these adjustments, the company’s diluted earnings per common share for the second quarter and first six months of 2007 would have been $0.43 and $1.14.

Excluding the impact of the extra week, as well as the effect of the severance and environmental charges in fiscal 2007, the company’s overall net income still grew over 60% for the quarterly period and over 30% for the six months. The increase in earnings was primarily due to the strong revenue growth, as well as higher operating margins in the company’s core laundry operations, which excludes our specialty garments and first aid segments.

Core laundry revenues increased 21% and 16.8% for the quarterly and six-month periods. Core laundry organic growth, which excludes the effects of the extra week, acquisitions, and fluctuations in the Canadian dollar exchange rate, was 7.6% for the quarter and 7.8% for the first six months. Excluding the severance and environmental charges from the fiscal 2007 results discussed earlier, the core laundry operations operating margin increased significantly from 8.2% on a pro forma basis in the second quarter of 2007 to 11% in the second quarter of 2008. The core laundry operations operating margin for the first six months includes increase from a pro forma margin of 9.7% in 2007 to 11.7% in 2008.

The improvement is primarily due to lower merchandise amortization expense, as well as lower payroll and related costs as a percentage of revenues. Fuel costs associated with our fleet of delivery vehicles continued to climb during the second quarter and offset some of these benefits.

Overall, we anticipate that rising energy costs will continue to provide margin pressure throughout the second half of the year.

The second quarter revenues of our specialty garments business were up 32.5% from $12.9 million in 2007 to $17.1 million in 2008. This segment’s income from operations increased to $0.4 million in the second quarter of 2008 from a loss of $0.5 million in the second quarter of 2007.

For the six months in fiscal 2008, specialty garment revenues were up 14.2%, with income from operations declining slightly from $2.5 million in the first half of 2007 to $2.4 million in 2008. The second quarter is historically a difficult quarter for our specialty garment segment as there are fewer power reactor outages during the winter when demand for energy is at its peak. Although this segment did have a strong revenue showing in the second quarter of 2008, much of this revenue growth was due to direct sales that were not as incrementally as profitable as our service business. As a result, the revenue did not translate into income at the levels consistent with the segment’s historically strong first and third quarter performances.

In addition, this segment absorbed costs in the second quarter related to start-up activities for a new U.K. laundry facility in Europe, as well as new clean room operation in the United States. We do expect strong second half results from this segment and are optimistic that this segment is on track to reach its full year growth and profitability goals.

Revenue from the company’s first aid segment grew 16.5% from $7.4 million in the second quarter of 2007 to $8.6 million in the second quarter of 2008. During the second quarter of 2008, this segment sold the remaining inventory of a discontinued product line. Excluding this sale, as well as the effect of the extra week during the second quarter, this segment’s revenues grew 5.5% and 3.8% during the quarter and first six months respectively.

Although our first aid business made up some ground in the second quarter from a profitability perspective, it is still behind last year’s first half performance. However, this was expected as this segment continues to invest time and resources reorganizing its operations.

The company’s results in the second quarter and six-month periods were also affected by slightly lower net interest expense as a percentage of revenues, as well as a lower effective tax rate compared to fiscal 2007. The provision from income taxes decreased from 39.25% in the second quarter and first six months of 2007 to 38.5% for the comparative periods in 2008. On an ongoing basis, we expect our income tax rate will be approximately 38.5%.

The company’s balance sheet and overall financial position continued to be very strong. Merchandise and service increased from $86.1 million as of our prior year-end to $90.8 million as of the end of our second quarter. It did however decrease from $93 million at the end of our first quarter. Controlling merchandise costs continues to be a priority of the company and we are clearly seeing some of the benefits of these efforts.

Capital spending for the first six months of 2008 was $35.3 million and we now anticipate capital spending will be approximately $60 million for the full year.

For the first six months of 2008, we also expended the total of $37 million on acquisitions, the bulk of which were to Western Uniform in September of 2007. During the second quarter, we made good progress integrating Western Uniform’s locations into our operations.

Total debt increased from $206 million at our prior year-end to $229.9 million as of the end of our second quarter. Total debt as a percentage of capital also increased to 30.2% at the end of our second quarter from 29.3% at year-end due to the increase in debt used to fund the acquisition of Western Uniform.

Based on the strong results through the first six months of the year, we would like to update the full year guidance from what we have previously communicated. We now expect that our fiscal 2008 revenues for the full year will exceed $1 billion and our diluted earnings per common share for the full year will be between $3.00 and $3.10. Despite the higher guidance, we project the overall softness in the economy coupled with higher energy costs will challenge our ability to maintain the same levels of growth and profitability achieved during the first six months. However, we are confident in our ability to meet these new projections and excited about the prospect of our company reaching these major milestones.

This concludes our prepared remarks and we would 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 Ashwin Shirvaikar with Citigroup.

Ashwin Shirvaikar - Citigroup

Thank you. I don’t think the cautionary outlook should take anything away from your performance, so congratulations on the quarter. The question I have is the new sales success that you had, what kind of clients are buying in this environment? And you did mention that the push back against signing longer term contracts, does that mean that you are now signing shorter term contracts, maybe more towards the three-year timeframe as opposed to five?

Ronald D. Croatti

I’ll take that one. About 8% of our business comes from the trades and constructions, or what I would call the SICs 15, 16, 17, when you wind them up. That’s where we are seeing the reductions and the cut-backs and the financial issues more than anything. I think where we are seeing where we are getting our new accounts and we are getting a little push-back on the contracts is on the smaller accounts because of the business uncertainty. And it’s a variety of sectors but it’s certainly -- we’re not writing much business out of that trades and construction, or construction support. It’s really -- you know, we’re still writing business in the other areas, you know, auto repair and healthcare and wholesale. Does that help you at all?

Ashwin Shirvaikar - Citigroup

That does help. How about the length of contract? Is that --

Ronald D. Croatti

Well, we’ve always pushed for a five-year contract. The only thing I could tell you is we’ve tried to work -- when I get the numbers up here, it’s -- we’re probably running at an average of about 4.6, 4.7 and that’s slipped down to about 4.5, so we are taking a few more three-year contracts.

Ashwin Shirvaikar - Citigroup

Got it. In terms of stock room efficiency, clearly you mentioned merchandise costs going down. How much can you push the stock room efficiency lever?

Ronald D. Croatti

The merchandise is affected as we lose more business and we get the reductions, hopefully we get paid for those clothes or we get the clothes back. If we get those clothes back, we recycle them and that helps lower our merchandise costs. And then when things pick up, we’ll have to basically put new garments in and it will just reverse the other way, so how bad will the economy go -- I mean, you can call that one as well as I. Hopefully it doesn’t go too bad and it stops at about 5% on the unemployment level. But that’s really what it amounts to. We get the clothes back. We reuse them for our existing customers.

Ashwin Shirvaikar - Citigroup

Got it. On a different sector, the first aid part of the business, with all the restructuring and all that, is that completely now behind you? Results are modestly better --

Ronald D. Croatti

No, I think Steve just told you we sold off one segment, a small segment so I’d say we have a couple of more quarters that we are fooling around with it. We are still not happy with our overall direction in that division.

Ashwin Shirvaikar - Citigroup

Go it. And final question on the European front, any progress on new contracts there for specialty?

Ronald D. Croatti

Well, our boys tell us -- I haven’t seen it yet -- our people over there are telling us that we are going to be getting -- the funding by the British Government has been loosening up on one of their clean-up sites, so we should be picking up that and by putting this plant in England that we are currently putting in, we should be getting new revenues from British Fuels and -- I forget the name of the other British power company, but we are supposed to be getting probably by next year when we are totally online next fiscal that we are supposed to be getting a substantial kick in revenues in that division.

Steven S. Sintros

And they’ve slowly started to get some business from -- obviously that U.K. business that’s going to be going into our U.K. facility was in our facility in the Netherlands and we’ve started to get some contracts out of France, Sweden, and some additional German contracts, which we are kind of lining up for the fall outages to help fill the gap of the earnings per share that’s going to leave our Netherlands plant and go to the U.K. So they have been planning for that and I think they’ve made some inroads into some of those other countries.

Ashwin Shirvaikar - Citigroup

Thank you, guys.

Operator

Our next question comes from the line of Michael Schneider with Robert W. Baird. Please proceed with your question.

Michael Schneider - Robert W. Baird

Maybe first, Ron, you can address the trendline through the quarter. Last time we were on the call, you had cited that they had started to deteriorate. Is there a consistent deterioration through the quarter itself as well?

Ronald D. Croatti

We have seen just about every week deteriorate, Mike. You know, I just try to compute it another way that we might understand it a little easier -- it looks like we are losing about 150 wearers a day. That’s our current -- John just slipped me the numbers. The answer to your question -- it has deteriorated significantly harder in February than September or October, almost double, triple.

John B. Bartlett

I think every year we typically see a falloff after the holidays, after January and February. I mean, they kind of hold on to the employees through the holidays and then they let them go but it’s been a much more dramatic fall-off this year in January and February.

Michael Schneider - Robert W. Baird

And Ron and John, is it concentrated in the areas of the country where there’s been such excess construction -- Southeast, Southwest, or has it hit some of even the stronger markets like the Texas area and the Gulf Coast?

Ronald D. Croatti

We only have one area that’s positive and that’s oil patch. Other than that --

Steven S. Sintros

It’s pretty much across the country, except Texas, you know, West Texas has stayed pretty strong.

Michael Schneider - Robert W. Baird

Okay, and then when you look at the margins in the core laundry business in Q2, you did have the extra week. You mentioned some of the lower cost merchandise as a result of uniforms coming back, but the performance still seems extraordinary and my numbers, you basically came up with about $8 million of operating profit that I wouldn’t have expected. That’s a big number. Can you give us any insight as to what you mean by tighter cost controls, if there’s been any unusual product sales or product confirms that bump that number in the quarter? It just seems like an extraordinary margin performance.

John B. Bartlett

There’s really nothing extraordinary, Mike. The biggest factor was the merchandise cost and just so you understand the extra week, I mean, even though we had an extra week of revenues, we account for all of our labor on a weekly basis and all of our depreciation and all of our garment amortization on a weekly basis, so there was not an extra week of revenues without the costs associated with it.

So if you actually look at it, you’ll see that the margins in the second quarter declined a little bit from the first quarter in the laundry business, so I think really what happened with the strong revenue growth, we really -- our margins didn’t deteriorate as much in the second quarter as they have in most prior years and -- it’s just a --

Michael Schneider - Robert W. Baird

So then --

John B. Bartlett

There’s no one thing. I mean, it’s just the control of the labor and the merchandise and if you don’t do that, you’re never going to --

Michael Schneider - Robert W. Baird

But I guess still surprised given that the organic growth rate was 7.6, last quarter it was 8.5. So the deceleration in organic growth hasn’t been that significant, so that the benefit for the merchandise costs overall for the business just doesn’t seem like it should have been that dramatic so quickly.

John B. Bartlett

I think what I’m saying is the second quarter was actually not quite as good as the first quarter. It was clearly much, much better than the second quarter of a year ago, but sequentially the performance was down a little bit in the second quarter.

Michael Schneider - Robert W. Baird

Okay, and I guess as you try to account for the softer economy then and the presumably the ad stop rate deteriorating further in the second half, does it -- are you trying to tell us that the margins won’t bounce up sequentially as they historically do? Are you anticipating the margins go flat from here?

John B. Bartlett

I think it’s possible the margin in the third quarter will be roughly flat -- I mean, at a pretty relatively high level. But I think the third quarter has typically been a strong quarter for us and we are expecting a strong from Unitech, our specialty garments in the third quarter. That’s where we have to make the money there to --

Ronald D. Croatti

Go back -- Unitech doesn’t make a fourth quarter, Mike. We are lucky if they break even, so -- but I think it goes back to what John is basically saying. It’s merchandise. We’ve got a tight control on labor. We certainly reacted -- we had a meeting some time ago when we saw things slowing that we went into phase one, you know, really telling our guys if somebody leaves don’t replace them unless they are absolutely positively necessary, so that’s helped the payroll a little bit. You know, we’ve certainly cut back on some travel, some meetings, and we foresee doing that the rest of the year.

So you know, it’s $50,000 here, $100,000 there and it’s all adding up. And have we got it all out? I don’t know, but we are certainly going to keep a tight rein on what we are doing.

Michael Schneider - Robert W. Baird

Was there a material reduction in the incentive comp around calendar year-end based on the trajectory --

John B. Bartlett

No. No.

Michael Schneider - Robert W. Baird

And then just on the guidance for the second half, if you look at what you’ve got left in the annual guidance versus what you posted in the first half, it basically means that earnings are going to be flat year over year in the second half, despite the huge momentum you had in the first half. Is there anything else you guys have baked in there as far as --

Ronald D. Croatti

No, I don’t believe -- they are not going to flat; 2.91 would be flat.

John B. Bartlett

I think the $3.00 to $3.10 envisions earnings growth in the second half of 7% to 15% year-on-year in the third and fourth quarters.

Michael Schneider - Robert W. Baird

Okay, and then final question on the fuel costs; they have been raging for the industry. Have you guys gone out with -- do you intend to go out with a fuel surcharge?

John B. Bartlett

Well, we have been very aggressive in doing that already and I think that’s clearly one of the things that’s helping us offset those costs. But of course, if they continue to go up, I guess we’ll continue to do what we can.

Michael Schneider - Robert W. Baird

And have your competitors followed?

John B. Bartlett

I assume they have. We don’t -- we’re not privy to exactly what they’ve done but I’m assuming they are trying to do that, yeah.

Michael Schneider - Robert W. Baird

Okay. Congratulations, guys. Great performance.

Operator

(Operator Instructions) There are no questions at this time. I will now turn the call back over to you, John. Thank you.

Ronald D. Croatti

I’ll take it. We’re very excited about our first two quarters performance and we’ve updated our guidance. I think we are very comfortable with the guidance, updated guidance we are putting out there and like I said earlier back in December, we went to what we call phase one tightened cost controls and we plan to continue in that mode at least for the next two quarters, and hopefully this business cycle will turn around and we will keep our sales effort at peak level.

So I appreciate your interest in the company and we look forward to talking to you in three months.

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.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!