UniFirst Corporation F3Q08 (Qtr End 05/31/08) Earnings Call Transcript

Jul. 2.08 | About: Unifirst Corporation (UNF)

UniFirst Corporation (NYSE:UNF)

F3Q08 Earnings Call

July 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

John Healey - FTN Midwest Securities Corp.

Andrea Worth - Robert W. Baird

Terry O’Connor – Feeder Creek

Operator

Welcome to the UniFirst Corporation third quarter earnings results conference call. (Operator Instructions) I would now like to turn the conference call over to John Bartlett, Chief Financial Officer.

John B. Bartlett

Welcome to UniFirst conference call to review our third quarter operating results for fiscal 2008 and to discuss our expectations going forward. My name is John Bartlett and I am the Chief Financial Officer. Joining me is 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 our results for the third quarter and first nine months of fiscal 2008, which ended on May 31, 2008.

Our net income for the third quarter increased 23.8% from the amount earned in the third quarter of last year. The increase is due to the improved performance from our core laundry operations and in simple terms, resulted primarily from the fact that our strong revenue growth was accompanied by tight cost controls, which increased our operating margin from 10.5% in the third quarter of fiscal 2007 to 12.3% this year. We are pleased that our focus to increase our operating margins is yielding results, particularly in locations performing below our standard.

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

I would like to welcome all of you who are joining us for the review of our third quarter and first nine months fiscal results for fiscal 2008. Steve will get into the details in a few minutes but I will begin with a brief recap.

We are very pleased to report our best third quarter and first three quarter performance for revenue and profits in the company’s history. Revenues for the quarter were a record $254.6 million and for the first three quarters they were a record $772.2 million. This represents a 10.8% increase for the quarter, compared to the $229.8 million in the third quarter of last year, and a 14.5% increase for the first three quarters, compared to the $674.6 million posted for the comparable period in fiscal 2007.

The primary contributors to these results continue to be our core laundry operations, which have sustained strong performance throughout the year, and our Specialty Garment business unit also aided in revenue growth.

Net income for the third quarter was $16.9 million, a 23.8% increase over the $13.7 million recorded in the third quarter of fiscal 2007. Net income for the first nine months of fiscal 2008 was a record $48.7 million, a 41.6% increase over the $34.4 million reported in the comparable period last year. Again, laundry operations led the way, showing solid profit increases, both for the quarter and for the nine-month period.

Similar to last quarter, profits were aided by a combination of lower merchandise costs, lower payroll costs as a percent of total revenues, and the fact that we booked an additional week’s results for the first nine months, 40 weeks of fiscal 2008, versus 39 weeks of fiscal 2007. Obviously, it helped bolster revenues and profits.

The slowness, which we have had and increased impact on the economy from the beginning of our fiscal year, finally caught up with us a bit in the third quarter as we saw professional weekly averages for new sales slip behind the previous quarters. Even so, due to an increase in total workweeks, overall new sales results continue to move ahead. Sales turnover reversed its downward trend from the previous quarter and ticked up slightly, due largely to the effects of tougher selling conditions and the greater difficulty for lower performing reps to sustain minimum standards.

Selling expenses as a percent of revenue continued to increase slightly but pricing on new sales held very steady. Related to the economic uncertainty, buyers continued to show some reluctance in committing to new programs. Our sales promotions to current customers continued to provide revenue increases from the previous year. And our national account sales team delivered about budget results.

There is no question the economy is having an impact on our business and making it more difficult to retain customers, control our ads over reduction matrix, and sell new accounts in both the local and national levels. In light of all of that, we are gratified we were able to sustain solid numbers through the first nine months and though we don’t expect conditions to ease, we think the momentum we have built will carry us through to the year-end.

The general economic outlook calls for sub-par growth, with weakness continuing in consumer spending, residential investment, and capital spending by business. The government stimulus checks may help a bit but most experts are predicting that the resulting spending will be concentrated on core needs and personal debt reduction, not on the purchase of discretionary items that traditionally have a greater impact on the economic growth.

Even though business inventories are already extremely lean, they are expected to decline further over the next couple of quarters. Overall business profits are expected to shrink, oil prices to remain high, credit markets to continue unsettled, and the dollars relative value to remain low. As if to emphasis the economic weakness, the Dow slipped to a Bear market territory, off more than 20% from its high in October of last year. In short, the outlook calls for continued caution.

The Institute of Supply Management May Index for Non-Manufacturing Industries came in at 51.7%, indicating service sector expansion for the second consecutive month. Indeed, 13 non-manufacturing industries reported growth in May but the ISM manufacturing index was reported at 49.6% and held below the 50% mark indicating sector contraction for the fourth consecutive month.

The unemployment rate rose to 5.5%, up by 0.5%, and the number of unemployed persons increased by over 850,000. Only health care and food services show any significant employment increase.

The combination of job losses, low consumer confidence, and the desire by business buyers to hold the line on new expenses are all negative factors that will likely affect us over the next three months into fiscal 2009. As we already noted, we have seen on ongoing increase in our wearer reduction numbers and we expect that trend to continue. Combined with the continued challenge of sales conditions we believe some slow down in revenues and profit growth is likely, but with the impact being mostly felt in the first quarter of our next fiscal year and beyond.

Like everyone else, we are astonished at the almost weekly increases we are seeing in fuel costs, up over 50% from a year ago, and are struggling with the additional price increases on everything from soap and chemicals to fabric and wire hangars. We will do our best to offset some of the impact from these price increases but probably will have to be absorbed by operations and that will be putting additional pressure on our bottom line.

As I said at the start, we are very pleased with the performance year-to-date. It is resulted from adherence to our strategic plan, maintenance of our tight operating controls, quick adjustments to changing market conditions, and the absolute dedication and continued hard work of all our team partners. These factors have been effective in guiding these three successful quarters and it is what we will rely on to carry us through the balance of the year. Although we expect tough economic conditions and a challenging market environment, we will prevail. We will continue to be optimistic about the results we will be able to achieve for the full year.

Now to fill you in on the financial details for the third quarter and first nine months, I would like to turn the call over to Steve.

Steven S. Sintros

As Ron and John discussed, we are excited to report revenues and profits are the best we have ever achieved for the third quarter and nine-month periods. Revenues were $254.6 million and $772.2 million for the third quarter and first nine months of 2998. This represents increases of 10.8% and 14.5% respectively. As we have discussed in prior calls, fiscal 2008 is a 53-week year for the company. The extra week fell in the second fiscal quarter and accounted for approximately 2.9% of year-to-year revenue growth for the first nine months.

Third quarter net income increased 23.8% to $16.9 million, or $0.87 per diluted common share, from last year’s third quarter net income of $13.7 million, or $0.71 per share. Net income for the first nine months of 2008 increased 41.6% to $48.7 million, or $2.52 per diluted common share, from $34.4 million, or $1.78 per share, in 2007.

As a reminder, our nine-month earnings in fiscal 2007 were affected by severance expenses as well adjustments made to our environmental reserves. These adjustments combined to decrease our income from operations and net income by approximately $2.3 million and $1.4 million respectively. Without these adjustments our diluted earnings per share for the first nine months of 2007 would have been $1.85.

The increase in earnings continues to be due to strong revenue growth as well as higher operating margins in our core laundry business, which makes up approximately 90% of our consolidated results.

Core laundry revenues increased 11.5% and 15.0% for the quarterly and nine-month periods compared to fiscal 2007. Core laundry organic revenue growth, which excluded the effects of the extra week, acquisitions, and fluctuations in the Canadian exchange rate, was 7.8% for both the quarterly and nine-month periods.

The core laundry’s operating margin increased from 10.5% in the third quarter of 2007 to 12.3% in the third quarter of 2008. The 2008 year-to-date operating margin was 11.9%, which is up from a pro forma operating margin of 9.9% in 2007 after adjusting for the impact of the severance and environmental charges discussed earlier.

The improvement in the third quarter margin is consistent with the first two quarters of this year and is related primarily to lower merchandise amortization as well as lower payroll and payroll-related costs as a percentage of revenues. The negative impact of fuel costs associated with our fleet of delivery vehicles continued to accelerate during the third quarter and partially offset these benefits.

The third quarter and year-to-date revenues of our Specialty Garment segment were up 11.7% and 13.2% respectively. However, income from operations decreased from $3.0 million in the third quarter of 2007 to $1.9 million in 2008 and from $5.5 million in the first nine months of 2007 to $4.4 million in 2008. As we discussed last quarter, much of this segment’s growth has come from direct sales, which have been less profitable, and incremental service business. In addition, overall costs for this segment have increased as a percentage of revenues due to higher energy, payroll, and other production and delivery-related costs.

Revenues from our First Aid segment fell 9.5% to $7.5 million in the third quarter of 2008 and have been relatively flat year-to-date, excluding the effect of the extra week. Income from operations for both the quarterly and year-to-date periods are down as well.

This segment has faced increased competition in the challenging economic landscape that has caused new sales to slow, customer losses to increase, and margins to be squeezed. In addition, the decline in third quarter revenues is partially due to a product line that was discontinued in the second quarter of fiscal 2008. We continue to invest in the training and reorganization of this segment’s sales force with the focus on reversing these trends.

Our overall results were also impacted by lower interest expense in both the quarterly and year-to-date periods due to lower interest rates affecting our variable-rate debt.

Our effective tax rate was 39.1% in the third quarter of 2008 compared to 37.3% in the comparable 2007 quarter. The variability in the quarterly rate relates to changes in state tax legislation as well as adjustments made to the company’s reserves for tax exposures. The year-to-date effective rate was up slightly from 38.5% in 2007 to 38.7% in 2008. We expect our effective tax rate to be approximately 39.0% on an ongoing basis.

Turning to the balance sheet, we have merchandising service of $91.7 million at the end of our third quarter, which represents a $5.5 million increase from year-end. This increase is primarily the result of acquisitions, as well as strong-use sales of our flame-resistant and other protective apparel.

Overall, however, our merchandise levels have increased at a rate much lower than our revenue growth, which has clearly led to the lower merchandise amortization discussed earlier. One factor affecting our merchandise is the decrease in wearer levels of our existing customer base. Although this is not a positive overall trend, we have shown over the years that during higher periods of unemployment we were often able to achieve better overall garment utilization by deploying the used garments we received back from customers.

We continue to invest in our infrastructure with capital spending totaling $50.5 million for the first nine months of 2008 and we anticipate capital spending will finish the year between $60 million and $65 million.

During the first nine months of 2008 we also spent a total of $51.1 million on acquisitions. In May 2008 we closed on the acquisition of Quality Linen and Towel Supply Company in Salt Lake City, Utah. Quality Linen, along with Western Uniform, which was acquired in the first quarter, have expanded our presence in two attractive markets. As always, we continue to be active in pursuing acquisitions which we believe will fit our long-term growth and margin expansion strategy.

Total debt increased from $206 million at year-end to $236.4 million as of the end of our third quarter. Total debt as a percentage of capital also increased slightly, to 30.1% at the end of the third quarter from 29.3% at year-end, due to the increase in debt used to fund acquisitions of Western Uniform and Quality Linen.

Heading into the fourth quarter, we now expect our fiscal 2008 revenues for the full year will be between $1.015 billion and $1.025 billion and our diluted earnings per common share will be between $3.15 and $3.20. We are very pleased with the results we have delivered thus far this year and the progress we have made expanding our margins despite challenging economic conditions. We look forward to closing out a record-breaking year for the company and providing you with some insight towards what promises to be a challenging 2009 when we meet again for our fourth quarter earnings release in fall.

This concludes our prepared remarks and I will now turn the call back over to the operator to facilitate any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Healey - FTN Midwest Securities.

John Healey - FTN Midwest Securities Corp.

You continue to post better organic growth rates and your margins continue to show a really nice pick-up despite the more challenging cost environment. When you look at how you’re managing the business today, is there any difference in how you’re managing it today compared to a year ago, and maybe any ways you see how you’re managing the business and you’re able to achieve these successes, than your competitor? What is different from how your competitors are managing their business?

Ronald D. Croatti

I don’t think so, John. I think it’s just that we have been focusing on a lot of operations and then the sales side. The automation of the sales force has helped us. That’s really driven a lot of the growth. I think as far as the structuring, you know, we made some minor changes on responsibilities for the sales. It’s certainly back at the regional vice president level and the corporate people, who are the support role. But that’s really the only structural change we’ve made.

I think the margin has improved because we’re focused on a couple of the operations that weren’t doing well.

John Healey - FTN Midwest Securities Corp.

When you look at 2009 and you look at the challenging environment, in your past experience with the industry, I was hoping to just get your thoughts as how you see this slow down compared to slow downs we see in the past. Maybe you thoughts on how it compares or how it’s maybe dissimilar to what we’ve seen in the past.

Ronald D. Croatti

About an hour ago I went and checked some numbers and the wearer numbers we’re forecasting to basically be at the 2002 and 2003 levels. So at this point we’re saying it’s going to be comparable. It’s that type of slow down as far as we’re concerned.

John Healey - FTN Midwest Securities Corp.

And lastly, you guys talked about acquisitions, just your thoughts there on what type of opportunities you’re seeing. Are you seeing more kind of small operators saying the business is getting tougher and they don’t want to deal with the downturn? Are you seeing more opportunities than you’ve seen in the past and how does the competitive environment look for those acquisitions?

Ronald D. Croatti

I think we mentioned this on our last call. I think we’ve seen more businesses basically looking to be divested in the last six months. And I think it’s driven by two things. It’s always driven by people and their estate issues and I think the people are looking at the tax law changes that are forthcoming with the new Democratic presidency in progress [laughter in background] it may impair them. So I think that’s what’s driving it and I think we’ve seen both mid-size and small companies at this point.

Operator

Your next question comes from Andrea Worth - Robert W. Baird.

Andrea Worth - Robert W. Baird

Great quarter. I just want to focus a little more on the operating margins. Obviously, you’re posting some phenomenal numbers there. It really sound like the fuel wasn’t as much of an issue this quarter. I guess maybe you could talk a little bit about what you expect the impact to be heading into the fiscal fourth quarter and your ability to keep offsetting that with the lower merchandise cost and lower payroll costs.

Steven S. Sintros

I wouldn’t say that the fuel wasn’t as much of an issue in the quarter. It definitely was a bigger issue than it has been in the last two quarters, obviously given the fuel levels. Between natural gas and fuel for the trucks, that hurt our margin about 9/10 of a point for the quarter, which is up from about ½ a point last quarter and only about 1/10 of a point in the first quarter. So it has definitely been hurting us more as the year has gone along but the benefits related to the merchandise and the payroll have more than offset it at this point and continue to keep our margin growth pretty constant throughout the year.

So we do expect that number that I gave you, the 9/10 of a point, to continue to accelerate. To what point, it’s difficult to project, obviously. I think the key is going to be to keep those other positive factors as much as possible, and that’s really going to be tied to our sales and our revenue growth.

Andrea Worth - Robert W. Baird

And on the merchandise cost, specifically, is there ability to continue to improve that even further from where you’re at or have you hit a plateau as far as the amount of the benefit you’re getting from the efficiencies there?

John B. Bartlett

I think it’s hard to say, Andrea, but I think Steve mentioned in his comments that the merchandise and service, on our balance sheet, has grown at a slightly lower rate than our revenue so that is a good sign that we just have less merchandise to amortize as we go forward. So I think that’s a key number to look at. If that number is growing faster than our revenues that means we’ll have more expense to absorb as we go forward. So, I guess at this point, I don’t think there’s going to be a lot of future benefit, but I don’t think we’ve bottomed out yet on that.

Steven S. Sintros

And I don’t think it’s turning imminently, but I’m not sure that we’ll be able to do better than we’re doing right now.

John B. Bartlett

Some quarter it’s going to turn and go the other way.

Andrea Worth - Robert W. Baird

And just in terms of really what you’re seeing, obviously your growth rate was very impressive this quarter, holding it constant despite what seems like a deteriorating environment. What did you see throughout the quarter as things progressed, did things actually get worse for you or was it more volatile? And just trying to get a sense of what you’ve seen during June, as well.

Ronald D. Croatti

I think the wearer shrinkage accelerated at the beginning of May. We’ve seen it accelerate May and June, to be exact. And that’s what makes us think that we’re going to be at that 2002-2003 level, if it stays based at that type of rate the next three months, and then we’ll be right there.

As far as competitive action on the street, we’ve seen more competitive action due to price on the street, whether it’s a big account or small account, and whether it’s a big supplier or small supplier, everybody’s running around trying to maintain their revenue and they’re trying to do it any way they can.

Andrea Worth - Robert W. Baird

And has pricing basically been stable for you this quarter? Probably 2.0% to 2.5%?

Ronald D. Croatti

Pretty stable on the pricing. We measure it in weeks of return on investment, our merchandise. We were stable this quarter. On the new business side, anyway.

Operator

Your next question comes from Terry O’Connor - Feeder Creek.

Terry O’Connor – Feeder Creek

Ron, maybe you could talk a little bit about the range of operating margin, either by facility or region or however you measure that because if improving a few of the underperformers having that sort of dramatic on the margin suggests your better performing regions or facilities must be in the mid- high-teens. And secondly, could you talk a little about specifically what you do to fix or improve underperforming operations? Is this largely you cracking the sales whip on the guys there or you fold in acquisitions and underutilized facilities, or is it both? Just talk a little bit more about high, low, and underperforming facilities, please.

Ronald D. Croatti

I think it starts with management; that’s the number one thing. We certainly look at the management and we certainly look at the sales effort. And then we also look at the pricing in those locations and we may push for higher price increases in those locations than some of the others to try and get that margin going. So it really comes back to management, in following the systems that we’ve got. You know, getting the pricing for our service that we should be getting.

Terry O’Connor – Feeder Creek

You maybe bracket the range of operating margins. I’m sure there are some outliers that you don’t need to talk about, but are your better performing operations in the sort of mid-teen area?

Ronald D. Croatti

I don’t think we give that out.

John B. Bartlett

I think we’ve talked in general in the past that there’s a wide range and we go from basically locations, which are fully allocated basis of break even and in some cases of new markets it’s a loss. Some locations are performing extremely well.

Ronald D. Croatti

It’s a bell curve.

John B. Bartlett

I think in addition to management, and management is the key, as Ron said, it’s really market share and your density. It’s where you’re in an area where you’re one of the major players, it’s a little easier to get the pricing and do the service than when you are in a new market.

Operator

There are no further questions at this time. I will now turn the call back over to you for your closing remarks.

Ronald D. Croatti

We certainly appreciate everybody’s interest in the company and we’re very confident for the remainder of fiscal 2008, with the guidance that we’re putting out there, and we’re looking forward to having a successful 2009. We appreciate your interest in the company and we look forward to reporting to you in the fall. Thank you very much.

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