UniFirst Corporation. (NYSE:UNF) Q4 2016 Earnings Conference Call October 19, 2016 10:00 AM ET
Ronald Croatti - President and CEO
Steven Sintros - SVP and CFO
Joe Box - KeyBanc
Andy Wittmann - Robert W. Baird
Nate Brochmann - William Blair
John Healy - Northcoast Research
Kevin Steinke - Barrington Research
Ladies and gentlemen, thank you for standing by. Welcome to the UniFirst Corporation Fourth Quarter Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions]. And with that, I’d now like to turn the call over to Mr. Steven Sintros, Chief Financial Officer. Please go ahead sir.
Thank you and welcome to the UniFirst Corporation conference call to review our fourth quarter results for fiscal 2016 and to discuss our expectations going forward. I'm Steven Sintros, UniFirst's Chief Financial Officer. Joining me today 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 risk factors. I refer you to the discussion of these risk factors in our most recent 10-K filing with the Securities and Exchange Commission.
Now, I will turn the call over to Ron Croatti for his comments.
Thank you, Steve. And welcome to everyone joining us for the review of UniFirst fourth quarter and full fiscal results for 2016. Our final numbers were released earlier today and I am pleased to report that 2016 was another record year for UniFirst.
Steve will be going over both the fourth quarter and full year details as well as our guidance for 2017. But let me present an overview of our 2016 performance.
UniFirst revenues for the fiscal year set a new record for our company, $1.468 billion, an [0.8%] increase over 2015 [$1.457 billion]. Net income for 2016 was $125 million, up slightly from last year’s $124.3 million, however it should be noted that this income was possibly impacted by $15.9 million related to the settlement environmental litigation. Excluding this gain, net income dipped 7.2%, Steve will speak more of this in a few minutes.
This past year was quite a challenging one, but despite the headwinds, our thousands of team partners throughout North America and Europe stepped up. Once again they consistently exceed our customer expectations with delivery of high quality service levels and in closing the new accounts they also needed to allow for this record breaking year and so our heartfelt thanks goes out to each and every one of our UniFirst family members for another year of a job well done.
As you may note, our Core Laundry operations make up 90% of our UniFirst's total business and accordingly our laundries led the way for a record revenue in 2016 reporting 0.5% year-over-year increase over 2015 results setting a new revenue record for this segment.
The gains were a result in part of our ongoing companywide commitment to excellence and all that our team do related to servicing our business customers and providing them with the highest quality products and cost effective value based management programs.
Revenue gains were also achieved by our combined professional field national account sales team delivering record new sales for the year by modest gains in customer pricing as well and solid add-ons from ancillary business services within our existing base. So again, I’d like to give credit to our tremendous team partners who have worked so hard all year long to overcome much adversity and allow us to achieve a year-over-year growth.
However, it should be noted as we have in past webcast, that the accomplishment of 2016 were achieved in the face of a significant, quickly uniform ware and the ancillary service losses both in our energy and energy related industries as a result of loyal, lower oil prices worldwide. The losses contribute to a negative as over reduction matrix for the year, which were also down more than from the 2015 levels. We were also charged throughout the year by a weaker Canadian dollar exchange rate versus the U.S. dollar.
These factors never really affected our top and bottom lines. That said income from operations from Core laundries fell short of the 2015 results decreasing 10.6% from last year when we excluded the impact of the settlement discussed earlier.
As for UniFirst subsidiaries, our specialty garment division, which provides work wear, specialized business services specifically for the nuclear and cleanroom industries bounced back in an anticipated in fiscal year 2016.
Revenues increased by 4.3% and operating income improved by 38.7% over 2015 results. We are encouraged by these results and believe these positive trends will continue in 2017 based on this segments ramp up schedule for nuclear reactor projects particularly in the Canadian market.
Finally, our First Aid and Safety segment reported improvements in annual revenue and a small dip in operating income from 2016 compared to last year, particularly a result in the decline in employment in the struggling energy markets, but the unit continues to maintain and the outlook is bright based on continued expansion of B2B First Aid and Safety operations.
And these opportunities are associated with our pharmaceutical packaging and wholesale operations as a result of steady demand for private label over-the-counter medication by retail chain stores specialty distributor.
So as we look ahead, we anticipate another slow growth year in fiscal year 2017 provided, but we do have reasons for optimism as we move forward. We are hopeful that the vast majority of our weekly losses related to the energy this sector experienced over the last two years are now behind us for the most part are at least stabilized at the point allowing for more accurate forecasting of opportunities and threats. But the oil industry, oil price expectations are an uncertain concern globally, so we continue to watch this closely.
Related to that, based on the results of our fourth quarter of 2016 and the start of our new fiscal year, we were hopeful the overall negative trend of ads over reduction metrics for last year will show some positive improvements through 2017 and we come closer than neutral. If these factors hold true, it will allow us to focus more of our efforts of sustaining quality annual growth and then spend less time strategizing to counter the losses.
And another positive note as we look ahead in 2017. In September we announced the acquisition of Arrow Uniform, historically a strong industrial laundry competitor in the Midwest market. We believe the two companies, people, systems and customers are well aligned to add up to 65 million in addition UniFirst revenue in fiscal year 2017.
2017 will now be without its fair share of market business challenges for our teams to overcome. First, we anticipate continued increases in labor and labor related expenses, staff recruitment initiatives and our ongoing CRM system overall project as well as other business investment design to bring long term returns. All these expenditures will affect our bottom line and play a role in projected decline in our earnings for 2017 as Steve will speak more of this in a moment.
Second, recent employment and economic forecast project only slight gains in the markets that we serve, limiting our new account acquisitions, opportunity as well as potential business expansion with current customers.
And third as always stiff competition with a likely challenging competitive landscape as well as customer pricing pressure will undoubtedly impact the new accounts sales, customer attention and topline.
So in order to help overcome these challenges ahead, it has been our mantra for several years now, we’ll be staying the course with their back to basic business in customer service approach in fiscal 2017 as this has been an effective strategy for us in the past from focusing on continued, involving staff education programs to help deliver service excellence at all level by investing in new sales initiative and sale systems by constantly and effectively communicating the UniFirst difference through customers and perspective customers, by managing all levels maintaining smart controls on spending and by always treating others, whether internal or external as we like to be treated.
We maximize our opportunities to deliver long term quality results for all of our UniFirst shareholders. By sticking to these basic business approaches and inheriting to the details outlined in our Vista 2020 strategic business plan, we expect to reduce solid year growth to UniFirst in 2017.
And with that said, I will turn it back over to our Chief Financial Officer, Steve Cintros for a detailed review of our 2016 financial results and for our outlook for 2017
Thank you, Ron. Revenues for the quarter, the fourth quarter of fiscal 2016 were $363.8 million, up 1.3% from $359.2 million a year ago. Net income was $35.5 million or $1.74 per diluted share, compared to net income of $28.9 million or $1.43 per diluted share in the fourth quarter of fiscal 2015.
As Ron mentioned earlier these results include the positive effect of a settlement the company entered into in August, 2016. The settlement related to environmental litigation and resulted in a $15.9 million gain that was recorded as a reduction of fourth quarter and full year selling and administrative expenses. Excluding the effect of this settlement, adjusted net income for the quarter was $25.8 million or $1.27 per diluted share down 10.8% from a year ago.
Full year adjusted net income was $115.3 million or $5.69 per diluted share down 7.2% from net income in the prior fiscal year. The current quarter results also reflect a $3.5 million increase to the company’s reserve for environmental contingencies.
This charge which is unrelated to the settlement discussed above was also recorded in selling and administrative expenses and decreased fourth quarter net income by $2.1 million or $0.11 per diluted share. By comparison in the fourth quarter of fiscal 2015 the company increased its reserves for environmental contingencies by $1.3 million which reduced net income by $0.8 million or $0.04 per diluted share.
Core Laundry revenues in the quarter were $331.7 million, up 1.6% from those reported a year ago. Adjusting for the effects of acquisition which increased revenues by 0.6% and a weaker Canadian dollar, revenues grew 1.1%. As Ron mentioned our growth during the quarter continued to be impacted by the loss of uniform wearers and customers in energy dependent markets in the United States and Canada over the last 12 months.
These reductions of wearers slowed in the fourth quarter but were still sharply negative. A strong performance in new sales in the fourth quarter helped the company finish the year slightly ahead of fiscal 2015s performance despite trailing through three quarters. This segment’s operating income adjusted to exclude the positive effect of the settlement discussed earlier was $38.3 million in the quarter, a 10.6% decrease from the prior year.
Its adjusted operating margin was 11.6% down from 13.1% for the same period in fiscal 2015. This decline was partially the result of increases made to reserves for environmental contingencies discussed earlier. In addition, many of the segments expenses including those related to its production facilities as well as selling and administrative efforts were higher as a percentage of revenues in the prior year.
These items were partially offset by lower energy expenses during the quarter compared to a year ago. Energy cost decreased during the quarter to 4% of revenues compared to 4.4% a year ago, due to lower fuel cost for our fleet of delivery vehicles as well as lower natural gas cost for our production facilities.
Healthcare claims were again sharply higher during the quarter as was stock based compensation expense the result of Ron’s April 2016 restricted stock brands. These items were largely offset by lower expenses related to workers compensation as well as other payroll related expenses.
Revenues and operating income in the quarter for Specialty Garments segment, which consists of nuclear decontamination and cleanroom operations, declined 2.8% and 18.5%, respectively, compared to a year ago. This segment’s results can vary significantly from period to period due to seasonality and the timing of reactor outages and projects.
For the full year, this segment produced solid results, with revenues and operating income growing 4.3% and 38.7%, respectively, over the same period a year ago.
First Aid segment reported revenues of $12.1 million in the fourth quarter up slightly from a year ago and its operating income decreased to $1.4 million compared to $1.5 million last fourth quarter.
UniFirst continues to maintain a solid balance sheet in financial position. Cash and equivalents at the end of fiscal year totaled $363.8 million, up from $276.6 million at the end of fiscal 2015.
Cash from operating activities declined 8.5% to $207.6 million primarily due to the timing of income tax payment. In addition the comparison of cash provided by operating activities was impacted by the settlement related to environmental litigation discussed earlier. A significant portion of the funds related to this settlement were not received until September 2016 and therefore did not translate into operating cash flows during fiscal 2016.
Of our cash on hand at quarter end, $54.9 million is accumulated by a foreign subsidiary intended for future investments outside the United States. For the full year, capital expenditures totaled $98.2 million. We continue to invest in new facility additions; expansions and automation that will help us meet our long term strategic objectives. We expect capital expenditures for fiscal 2017 to be between $90 million and $100 million.
Although we did not close any significant acquisitions in the quarter, as Ron mentioned we did close our acquisition of Arrow Uniform on September 19. This was an all cash transaction structured as an asset purchase with UniFirst acquiring substantially all of Arrow’s assets and virtually none of its liabilities for purchase price of approximately $122 million.
Business acquisitions have historically been an integral part of our growth strategy and will continue to seek out opportunities that make sense for us and meet our long term business goals.
After the closing of the Arrow deal, we still have over $275 million in cash on hand and significant borrowing capacity available under our recently renewed line of credit for additional acquisition, opportunities and other capital allocation options.
At this time we would like to provide you with our initial outlook regarding our operating results for fiscal 2017. We currently expect that revenues for fiscal 2017 will be between $1.550 billion and $1.565 billion, and full year diluted earnings per share will be between $5.00 and $5.15.
The projected decline in our earnings next year is primarily the result of slower top-line growth -- the slower top-line growth that we've recently been experiencing coupled with increases in labor and labor-related costs, as well as the impact of other investments we continue to make in our company.
As I mentioned earlier we continue to experience wearer reductions at higher than normal levels which continue to be a headwind with respect to our top-line performance. Although we continue to experience these reductions at higher than normal level, our current guidance does not assume any significant further deterioration in our wearer base, and it's very difficult to project how long and at what depth our results maybe impacted.
We are cautiously optimistic that with the recent improving trends of additions versus reductions that we maybe heading towards achieving stability in our wearer base that will allow us to begin to grow our top-line at higher levels.
This outlook assumes between $62 million and $65 million of revenues to be contributed from the acquisition of wearer uniform. We've also built into our outlook approximately $0.07 per diluted share of dilution relation to Arrow.
This dilution includes approximately $6 million of non-cash purchase accounting charges, as well as other transition costs. This estimate could vary based on the final purchase price valuation as well as the pace and success rate of integrating Arrow's operations.
As with any acquisition our goal is to make decisions that are best for our new customers and employees as we place the high priority on retaining both. This can extend the period in which synergies are recognized, however we feel focusing on these priorities ultimately achieve the more successful long term integration of the operations.
In addition to the impact of Arrow there are several other items we are projecting will contribute to our lower projected profits for fiscal 2017. Our selling and administrative cost, payroll costs continue to be increase as we continue to bear additional costs including headwind additions to support our CRM systems project and other technology initiative.
In addition we have recently invested in sales management position. These investments are important for the long term success of the company as it will allow us to provide additional guidance and support for our local operations.
We expect this investment to ultimately results in improved sales and operational efficiency but likely will result in margin pressure in the short run in fiscal 2017. Cost relating to our production and service labor continue to increase, partially the result of increasing minimum wage in many states and cities.
In addition, we expect our cost to be negatively impacted by recent update to the Fair Labor Standards Act which is expanded the pool of employees who are eligible to receive overtime pay.
Another area of projected margin pressure is increasing healthcare costs. As we have discussed throughout the year healthcare costs were significant headwind in fiscal 2016 in large part due to a small number of large claims. We have projected more modest increase in these costs in fiscal 2017.
Energy prices particularly natural gas, but also gasoline for our route vehicles have also increased over the last quarter. These levels although still low will cause some margin headwind assuming our low growth projections.
As we discuss last quarter Ron signed a new employment agreement in April under which he have the ability to earn up to 140,000 share of restricted common stock. Shares are earned based on the achievement of certain performance based criteria.
Included in our fiscal 2017 outlook, a stock compensation expense of approximately $4.2 million related to this grant. By comparison stock compensation expense in fiscal 2016 from Ron's prior and most recent grant was $2.2 million.
This incremental expense will impact earnings by approximately $0.06 per diluted share. In addition earnings per share will also be impacted by additional $0.04 as a result of the dilutive impact of the restricted shares issued.
And finally, we continue to make investments in our plans to improve capacity levels, efficiency and other customer's service level. These investments over the last few years have increases depreciation levels ahead of revenue growth.
I do want to mention that approximately $9 million to $10 million of these incremental costs relate to non-cash item such as depreciation, stock compensation and intangibles and amortization related to Arrow. So although our guidance calls for earnings to be quite a bit lower than fiscal 2016, the drop in projected cash flows is not as significant.
Many of these increases in expenses that I have discussed are viewed by UniFirst as important investments in our people, systems and infrastructure that will allow us to meet our long term objective.
In the short term as we struggle with macroeconomic factors impacting our top-line performance we will feel the pinch on our margin. We will continue to update investors and the status of these investments as we move forward, as we are committed to ensuring that they will provide long term success for UniFirst and its shareholders.
Finally, I do also want to note that our guidance for fiscal 2017 does not include any depreciation related to our CRM systems project as we do not expect that we will begin deploying the system during the current fiscal year.
As we move closer to deployment we will also likely begin to incur costs that do not qualify for capitalization on the accounting rules. In addition, additional headcount maybe needed to support the new system during deployment.
We have not included any of these costs in our guidance for the next year as it is unclear as to the timing and the amount of these expenses. We will continue to update shareholders and the impact of such costs in the quarters ahead.
This completes our prepared remarks and we'll now be happy to answer any questions that you may have.
[Operator Instructions] And our first question from the line of Joe Box from KeyBanc. Please go ahead.
Hey, good morning, guys. Thanks for taking my question here. So, guidance at the midpoint implies operating margins, a bit under 11% for FY 2017 or about 150 basis points lower than this year. Steve, I appreciate the quantification on incentive comps and amortization expense from Arrow, but it would be helpful if you could maybe quantify or just give us more color on some of the other big drivers like labor inflation, so we can get a sense of the year-over-year change?
Sure. Like you said I think you have some of the pieces that I gave you with respect to labor, we're assuming overall labor cost to be up about a 0.5% with respect to our operating location. And that really, Joe is the combination of minimum wage increases, as well as some of the projected increase from the Fair Labor Standards Act.
Now, I do want to clarify that some of that increase is not specifically related to, for example, certain states minimum wage being higher, but overall wage compression that we are seeing due to the upward pressure of some of our lower wage workers. That combined with the fact that slower growth in the top-line is causing any increases that we give to our employees in these areas to compress the margin in that area. So, I don't want to give the impression that its solely related to minimum wage in the Fair Labor Standards Act, but those are two things contributing to that impact.
Let me kind of help Steve here, Joe, its Ron. It’s a political year and the employees only hear $15 an hour, free healthcare in two, three years of college. We don't have people at minimum wage, but we have lot of people in that $10, $12 range and those have to go up, that's what they hear is the political pressure and we want to remain non-union, so we have to make some adjustments to keep that crew happy.
Understood completely, I guess maybe just to be specific, relative to the EPS guide, what would the guidance have been for FY 2017 if you would have just ex-ed out Arrow completely?
If we taken out Arrow completely, I believe I said it was about $0.06 or $0.07 diluted earnings related to Arrow.
Okay. Got it. And then I guess I would be remiss if I didn't ask you about the Cintas and G&K deal. Do you think the competitive dynamics change at all here? And then more specifically, Ron, how do you and the other folks on the board feel about your closest peer getting taken out at about four turns higher than UniFirst? Does that change the way that you guys look at capital allocation, or is this more of a stay the course on strategy?
Well, I think the merger is good for the industry in some respect its certainly get rid of the one of the lower price competitors. So I think that will help long term. How you do with 100 pound [Indiscernible] I don't know, but we got to work on that one. But I think it’s a good move for the industry long term. I think as far as the value of our company and it certainly puts us in the number two position now and we will continue to look forward to make acquisition to expand our revenue and our growth and our profits.
I mean specifically does this accelerate your willingness to do deals, I know you guys announced Arrow, but are you going to be more competitive in the space now to compete with those guys, or will there be no change to the strategy?
Well, I don't think there'll be much change to the strategy, if anything I think it's probably pushed the pricing up a little bit. Everybody is going to want what G&K got, that's pretty sure. But again it goes back the dynamics of people trying to serve their family estate and family issue, I mean, this Arrow one took us 10 months to close.
Got it. Okay. Thank you.
The next question is from the line of Andy Wittmann with Robert W. Baird. Please go ahead.
Hi, guys. I was just kind of curious on the top line, if you could give a little bit of a sense, Steve, on how much the energy stops were hurting you. Can you give us an estimate like you have in the past about what was the organic growth rate kind of ex-energy?
Yes. Andy, I still think it would be in about that 3% to 4% range, I mean, we look at our company and our operations in different regions and we have two regions close to three I guess, if you include Canada, but that are really impacted by the energy customers. Although the impact has trickled into other regions, and the non-energy regions if you want to call them that, and there's a lot of crossover so it's not that simple, grew during 2016 by almost 4%, but some of those energy specific regions were down close to 10%.
So that just gives you the sense of the mix of what we're seeing there. We still have regions of the country that are doing fairly well from a top-line perspective. And I think that's really what we're dealing with. So, I still think we'd be at that 3% to 4% without some of the impact of the reductions. I think the unfortunate part is that the reduction certainly continued for longer through fiscal 2016 than we anticipated and as you know since we're a weekly revenue business and our revenue sort of builds on each other week after week, those continue reductions put us in a position where at the end of year our revenue base was in a heck of a lot higher than it was at the beginning of the year despite a solid year of new sales. And that's really what's putting us in position of another slow growth year for next year.
Got it. Thank you for that. Excuse me. I guess my next question would be just on the guidance and the integration of Arrow. I have to imagine there's going to be some expenses that you're going to incur as that deal folds into your overall portfolio. Are those costs, if any -- first of all, can you maybe quantify those costs for us? And second off, could you give us a sense if that's part of the reason your guidance is where it is or if that's excluded from your guidance range?
I wouldn't think that's probably not a significant impact in the guidance. It is somewhat included in our numbers. We sort of took what Arrow's profitability was backing up some of the non-cash increases, as well as some of those transition cost to come up what we felt the dilutive effect of Arrow was for this year. Now that integration will continue over the next couple of years and you'll continue to have some cost related to integration as we go forward, but I think that's part of dilution that we guided. I don't think there's a significant other chunk that I think you're referring to.
Okay. Great. I think that it. Maybe I'll circle back if I have any more later. Thank you.
The next question is from of Nate Brochmann with William Blair. Please go ahead.
Good morning, gentlemen.
So, I wanted to talk a couple of follow-ups here just on the cost side in terms of the added capacity. I think that you guys had a couple of plants or a new plant that came online that I assume that that's part of the depreciation going into next year, and if you could just talk about the need for any additional capacity.
Well, I think we're always looking to improve plant operations and our coverage model. The two new plants that we added during fiscal 2016, I think we talked last quarter one was in Baton Rouge and one was in New Jersey, both fill areas that we had coverage but no processing coverage. And based on the capacity and of other plants and how that those were starting to become filled, we view these as good growth areas for us, and we've talked about before having a plant in a market provides better customer service, better customer visibility, typically better sales, and so those two investments were made as a result.
We continue to have plants on tap for physical 2017. Again, we've been growing despite the issues in Texas and some of the other markets. We’ve been growing petty well on the West Coast and plan to add another plant out there as well. So, it just a normal sort of growth of the business where we have branches that fill processing or service needs and when those branches get large enough and want to put in a plant we go ahead and do that.
And what's the incremental depreciation related to what you put in last year?
I don't have that exact number in front of me, Nate, its build in obviously to our depreciation guidance. Depreciation is going to be up about $0.2 or $0.3 is the contributing factor because of the low growth and the increase is not all because of those two plants, some is additional growth in other investments we're making in technology and automation but those two plants are component of it.
Okay. But $0.2 to $0.3 its good, extra color. Thank you. And then in terms of the oil and gas patches, obviously you guys both talked about feeling of that more comfortable that things are starting to stabilize little bit, could you talk a little bit about just what you're seeing in terms of the incremental oil and gas whether its specific customers or in those areas about in terms of just like the incremental people that are either walking away or still reducing headcount or whatnot relative to say, the trend over the last six months or so to give us a little bit of confidence that may we are nearing the bottom in terms of stability there?
I think the best way I can explain it to you is that we look like I said, look at it region by region, location by location and our more recent benchmark was our September results for additions versus reductions, and you look in those very heavy energy dependent markets like West Texas and Oklahoma city and Corpus Christi and some of those other places. And the September versus September comparison was very favorable in those energy specific market, and that's consistent with what we're getting talking to our local management is that the pure energy companies for the most part have made their cuts.
I think over the last quarter or so, the reductions that we're seeing are more in the downstream impact that I think we've mentioned. Companies that supported the energy industry that maybe try to hold out longer than the pure energy companies in making their cuts, but over the year and a half this is gone on for eventually we had to make cuts of their operations as well.
So, I think we're certainly further along in the cycle, and I think the recent performance like I said I think cautiously optimistic is the right word, I think we're certainly not claiming victory that things are stable now and we're moving forward, but we have seen better pattern.
Okay. Okay. And then just related to kind of like payback periods, clearly maybe not the headcount related to the CRM or some of the other IT initiatives but related to in terms of just growing the sales force, and then even some of the new additional plants. And I know that I probably know this from the past, but could you remind me a little bit in terms of when does a new salesperson kind of ramp in terms of like the number of months, and then also, too, in terms of what the payback period is in terms of usually a typical new plant addition?
Well, on the sale side, I'll take that first part, it’s basically about 39 weeks before you really see any value out of this new sales rep. Certainly the first 13 weeks is nothing but training and to get them in the right mentality, I guess the best definition I've got for you, it’s like raising children, be them along, but the second part of your question, on the plants and I'll ask, I think I'll refer to Steve on that one.
Well, I mean the new plant is a long term investment, it’s not having that new plant doesn't immediately give you more business in that market, it’s really moving business around, but it allows you to process it more efficiently and it provide better customer service in that market. During that first year when you plant you do have transitional cost around hiring a new team, getting up to speed with your labor force and all those kind of things.
But I think after the first year of a new plant being on line you should be settled back in sort of right-size all your costs so that new plant can be -- meet sort of our average profitability thresholds.
Okay, great. Hey, I appreciate all the extra time.
The next question is from the line of John Healy with Northcoast Research. Please go ahead.
Thank you. Ron, I want to get your thoughts kind of where we are at in terms of the competitive trends in the industry right now, your thoughts on the expectations being of a slower growth year kind of two years back to back. Are you starting to see the changing behavior where some of the players are being more aggressive on price, or are people still pretty rational out there?
Well, I think the last few years, the pricing was an issue. I think we made that comment numerous times that we've seen some irrational pricing. And I'll go back and I'll say that the merger of G&K and Cintas is a good move for the industry. It will help the pricing market, I'm sure.
Got you. And I wanted to ask, when you guys have done acquisitions in the past, what's typically the retention ratio of the amount of business that you are able to keep from the acquired entity?
It’s a good question. Typically the fall off is sort of similar to our normal business, I think it’s, and again that speaks to some of my comments I made about, the time it takes to recognize the synergy, I mean you really have to tread lightly with the customer base, make sure they understand that they're continue to get good service that they expected to get and we're not just going to move around the customers like pawns to maximize profits in the short term, because that's when you can customers that really challenged whether they should be going out to bid or doing something different to avoid the disruption. And so, I think if we do it right, we should be able to retain a very high percentage and maybe even do better than our average retention rate, that's certainly our goal.
So the $65 million or so in revenue associated with Arrow, is it reasonable to think they did about $70 million of business last year, or how should we think about that?
Yes. They were pretty close to that. I think that's about right. And so they are selling new business as well, so I mean they lose the accounts in the normal course and replace with other accounts as well.
Okay. And then I just wanted to ask just kind of a weather-related question. I feel like weather is always either a helpful factor or hurtful factor every year. If we have a rough winter weather season like people are expecting, do you guys see that as a good thing for the business in terms of kind of the match business and some of the outerwear stuff picking up more, or do you see that kind of not really something that is going to drive -- move the needle much?
I think depending on how dramatic it is, it can be a negative, I mean, Ron and I were just talking before the call about the hurricane last week and we saw some blip in our revenue from our plants in the Southeast. There were some flooding, some customers were impacted. So, I think when you have the real dramatic bad weather like winter from two years ago I think overall it's probably a negative with some fallout from those big storms.
Got you. Thank you, guys.
The question is from the line of Kevin Steinke with Barrington Research. Please go ahead.
Good morning. Just circling back on the improvement in wearer levels that you are seeing, is that mostly just a function of, again, fewer layoffs in the energy patch, or are you seeing any pockets of hiring anywhere in other industries?
I think it’s really just annualizing or hopefully getting passed most of the heavy layoffs in the oil patch. I don't think in the other regions that we have and had as bad performance, we're seeing much of a pickup there. So I think it’s really just a little bit better performance in some of the energy patch.
Okay. That makes sense. And you called out energy costs and healthcare costs as a potential headwind in fiscal 2017. I don't know if you could potentially quantify the impacts that you are baking into your guidance from energy and healthcare costs?
Energy I have at $0.2 and healthcare is probably $0.2 to $0.3. And healthcare is wild card, we'll certainly admit. We didn't expect the increase that we absorb this year with respect to small number of very large claims. Like I said in my comments I'm projecting more of a modest increase in healthcare with any luck we could ever flat here in healthcare, but your questions are good one and baked in is about $0.2 to $0.3 of a headwind from healthcare.
Okay. Is the higher healthcare claims just again a function of some unusually large claims, or are you seeing any impact from Obamacare or the regulatory environment?
Well, I think it’s all of the above, as we've talked about the Affordable Care Act required us to provide uncapped plans to all our employees whereas previously we had one plan, a lower cost plan that was more affordable for our lower wage employees who had an annual cap on coverage.
When that went away we now became more exposed to large dollar claims than we had been in the past. And those can come and go. And so I think it’s a combination of certainly a tough year for large dollar claims which is partially the impact of the Affordable Care Act, but partially just the impact of I think the way some large claims came through in the current year. But even if you strip all that out, I mean everything you are reading in the paper, the cost of healthcare in general continues to go up at more than inflationary, normal inflationary rates. And so I think it’s a combination of the two.
Right. Okay, okay makes sense. And on the Arrow acquisition, I don’t know if you would be willing to give any more details just in terms of the growth of that business or the margin profile of that business?
Well I think you can sort of back in to the margin profile based on the impact of some of the purchase accounting charges that we are seeing in our projected drag on earnings this year. The operation was far or less profitable than one of our normal operations. And so that is certainly going to expect over the course of the next two to three years to get that operation up to a level of profitability more in line with some of our standard operations, but in the short term that’s going to create a drag and a little bit longer payback on the acquisition, but we do think it was a good fit with a good customer base, it just needed to be -- it just needs a little more time and effort than maybe some other deals we’ve had.
Okay, fair enough. And with you completing the Arrow deal, and you made a small acquisition in the third quarter too as well. I believe, do you feel like the acquisition environment is loosening up at all or are these just kind of one-offs that you had to work on a long time and they finally came to fruition?
I do think that many of these companies as Ron has mentioned they are family owned companies many who have started around the same time in the same generation and now you are two or three generations in and I think we are getting to the point where more of these companies are getting to that time where succession and the continuity of the business is becoming a bigger issue. And I think Arrow and the acquisition we did in Chattanooga were both those similar situations. So from that perspective we may see more companies that are starting to get to that point in their lifecycle.
Right. Right, okay makes sense. And then on merchandise amortization how do you see that trending in fiscal 2017 in terms of what’s factored into your guidance?
Factored into our guidance is really sort of a flattish year for merchandise. One of the factors that is impacting our profits being down and I’m being a little contradictory I’m saying merchandise is flat, but I think in a normal environment when our growth was this slow we’d probably be seeing some more merchandised benefit than we are seeing. And I think I’ve talked a little bit last quarter, some of that is due to the growth in sales in the national account arena and we’ve had some large recent wins and those have a significant upfront investment in merchandise. So I think we’ve picked up some good large accounts for the long run, but having a larger mix of national accounts as you know our sales base is causing an offsetting impact on merchandise.
So if you look at the business regionally merchandise is way down obviously in the energy patch but its running higher in some of the other areas as a result of some of these large accounts.
Okay. One last question. Do you have a specific outlook for the Specialty Garments segment incorporated in your guidance that you could share?
Sure. That business we expect to be or what we’ve guided that it’s up above 3% in revenues and profits for next year. As we’ve talked about there can be a lot of volatility in that business. They have some projects coming down the road that we hope to get. We are optimistic that whether it comes at the tail end of this year into next year, there is some larger projects in Canada that they expect to get so the outlook there is fairly positive, but at this point what we’ve built in to the guidance is about 3% up in top and bottom line.
Okay. Thanks for taking my questions.
The next question is a follow up from Andy Wittmann with Robert W. Baird. Please go ahead.
Great, thanks. Ron, I was just curious as to your thoughts on the potential fallout from the regulatory environment on the Cintas and G&K deal. I think there's a general belief out there that there might be some specific cities where there will be maybe too much competition or too little competition. Do you have a view on that, and do you think there's any potential -- how much revenue do you think could ultimately be up for grabs from other players if any?
Andy, the only thing I could tell you is I really have no insight. What I would like, and what will happen is up to the government I mean. That’s all I could tell you.
There are certainly certain markets Andy that the overall between Cintas and G&K is fairly great through the Midwest in Chicago and Minneapolis. And so, like Ron said, I mean how that will ultimately be viewed and how the regulators look at the market and the industry, I think you guys do a good job following the industry and the market and what will be included in that market, is it just uniform rental, is it linen company, is it companies that sell uniform, so how all that is digested I think remains to be seen, but there are certainly areas where there is some decent size overlap.
Okay. I think, I’ll leave it there. Thank you guys.
We have no other questions.
All right. We’d like to thank all of you for your interest in UniFirst in our 2016 financial performance. We look forward to talking to you again in January when we will be reviewing our first quarter results for fiscal year 2017. Thank you and have a great day.
Ladies and gentlemen, that will conclude the conference call for today. We thank you for your participation and you can now disconnect your lines.
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