UniFirst Corporation — Q2 FY2019 Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended February 23, 2019; comparisons are to the periods ended February 24, 2018. Unaudited results. UniFirst provides workplace uniforms, protective clothing, laundry and facility services, specialty garment services, and first-aid products.
Financial performance
| Metric | Q2 FY2019 | Q2 FY2018 | First half FY2019 | First half FY2018 |
|---|---|---|---|---|
| Revenue | $437.5 million | $419.3 million | $876.0 million | $835.0 million |
| Operating income | $62.4 million | $42.0 million | $112.9 million | $93.9 million |
| Operating margin | 14.3% | 10.0% | 12.9% | 11.2% |
| Net income | $47.6 million | $58.4 million | $85.9 million | $92.6 million |
| Diluted EPS, common stock | $2.48 | $2.85 | $4.46 | $4.53 |
| Operating cash flow | Not reported separately for the quarter | $128.7 million | $118.9 million |
Q2 revenue rose 4.3%; first-half revenue rose 4.9%. Core Laundry Operations generated 90.2% of Q2 revenue and grew 4.1%. Management estimated 4.0% organic growth for Core Laundry in both the quarter and first half, excluding acquisition effects and currency impacts. Specialty Garments revenue increased 10.1% in Q2 and 15.8% for the first half; First Aid was nearly flat.
Cost of revenues increased faster than revenue: to 64.4% of revenue in Q2 from 63.3%, and to 63.8% for the first half from 62.2%. Management attributed pressure primarily to higher production, service and delivery payroll and merchandise costs; lower healthcare claims partly offset the increases. Selling and administrative expense fell to 15.6% of Q2 revenue from 21.1%, primarily reflecting a one-time CRM contractor settlement gain. Depreciation and amortization increased 7.7% in Q2 and 9.1% in the first half, mainly due to capital spending placed in service.
Cash, liquidity and debt
Cash, cash equivalents and short-term investments were $335.3 million at February 23, 2019, up $64.8 million from August 25, 2018. Working capital was $668.9 million. Operating cash flow for the first half was $128.7 million; capital expenditures, including capitalized software, were $52.2 million. The company stated that cash, expected operating cash generation and borrowing availability should meet anticipated working-capital and capital-expenditure needs for at least 12 months.
UniFirst had no borrowings under its $250 million revolving credit agreement, with $71.8 million of letters of credit and $178.2 million available. It reported compliance with all covenants. Total liabilities were $373.3 million and shareholders’ equity was $1.581 billion at quarter-end. The filing reports no off-balance-sheet arrangements.
Material changes and unusual items
- Operating income increased 48.9% in Q2, but included a $21.1 million gain from settlement with the contractor on the previously impaired CRM system. The gain included a $13.0 million cash payment, forgiveness of amounts owed, and hardware and maintenance services. The company recorded a $55.8 million noncash impairment charge on the earlier CRM version in fiscal 2017.
- First-half selling and administrative expense also benefited from a $3.0 million environmental-litigation settlement gain in Q1, lower healthcare claims, and capitalization/deferral of certain CRM and contract commission costs.
- Net income declined despite higher operating income. The prior-year Q2 included a $20.2 million tax benefit associated with U.S. tax reform; the current-quarter effective tax rate was 24.9%, versus a prior-year tax benefit rate of 34.0%. First-half effective tax rates were 25.5% and 4.2%, respectively.
- Operating cash flow improved year over year, partly due to the $13.0 million CRM settlement receipt, the Q1 environmental settlement receipt, and improved collections; offsets included employee bonuses and increased merchandise placed in service.
- The company adopted the new revenue-recognition standard in FY2019. Adoption increased opening retained earnings by $39.4 million and capitalized contract costs; it added $1.0 million to Q2 net income and $1.7 million to first-half net income compared with historical accounting. Operating cash flow was unchanged.
- The board authorized up to $100 million of share repurchases in January 2019. UniFirst repurchased 45,000 shares during the quarter for an average $139.57 per share. Quarterly dividends declared were $0.1125 per common share and $0.09 per Class B share.
Outlook, risks and contingencies
The filing provides no specific revenue, earnings or margin guidance. Management noted expected fiscal 2019 pressure from minimum-wage increases and wage competition, and continuing healthcare-cost inflation. It also identified energy prices and activity in energy-producing regions, customer retention and wearer levels, competition and margins, labor relations, foreign exchange, acquisition integration, and seasonality as factors that may affect results. Specialty Garments is sensitive to nuclear-plant outage timing and project activity. Management cautioned that interim results are not indicative of full-year results.
Environmental remediation liabilities were $25.4 million at February 23, 2019, net of the company’s accounting estimates; estimated net anticipated costs in current dollars were $25.8 million before inflation and discounting adjustments. Exposures include multiple sites, unresolved EPA comments at Woburn, and transit-authority reimbursement demands and a state audit relating to Somerville. Management said estimates and reserves may change, and future contingencies could materially affect results. Nuclear garment decontamination services are subject to regulatory risks. The company also disclosed currency exposure and a CAD forward-hedging program; a 10% exchange-rate movement would have changed reported period revenue by an estimated $3.4 million for Q2 or $6.8 million for the first half.
Important facts for investors to verify
- How much of the operating-margin improvement reflects recurring operations versus the $21.1 million CRM settlement gain and other settlement or accounting effects.
- Whether organic Core Laundry growth and pricing can offset rising labor, merchandise, healthcare and other operating costs.
- The magnitude and timing of environmental remediation payments, insurance recoveries, and any changes to recorded reserves.
- Progress and spending on the replacement CRM project, including the effect of capitalized costs and the prior system impairment.
- Cash deployment under the $100 million repurchase authorization, dividend policy, and continued availability under the credit facility.
- Effects of tax comparability, foreign-exchange movements, energy-market exposure, and Specialty Garments seasonality on future results.