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Unifirst Corp (UNF -1.42%)
Q2Â 2020 Earnings Call
Apr 1, 2020, 9:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Greetings and welcome to the Second Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Steven Sintros, President and CEO. Please go ahead.
Steven S. Sintros -- President and Chief Executive Officer
Thank you and good morning. I'm Steven Sintros, UniFirst's President and Chief Executive Officer. Joining me today is Shane O'Connor, Senior Vice President and Chief Financial Officer. We'd like to welcome you to UniFirst Corporation's conference call to review our second quarter results for fiscal year 2020. This call will be on a listen-only mode until we complete our prepared remarks, but first a brief disclaimer.
This conference call may contain forward-looking statements that reflect the company's 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. For more information, please refer to the discussion of these risk factors in our most recent 10-K filing with the Securities and Exchange Commission, as well as the Form 10-Q that we will be filing next week.
I want to start the call by saying that our thoughts go out to all those impacted by the coronavirus pandemic. This is an unprecedented time for our company, the country and the world and first and foremost, our thoughts are for the safety of all those dealing with the impact of this virus. As a company that services so many essential businesses that are critical to keeping our communities safe and operating, I also want to sincerely thank UniFirst's thousands of employee Team Partners, who are doing everything they can to continue servicing those customers during these uncertain times. We continue to be up and running as a business and are focused on working through the practical challenges of operating in this environment. Our top priority is working to keep our employee Team Partners safe, while they work to continue servicing our essential customers who remain open.
Customer closures have begun to accelerate over the last two weeks, but it is still too early to determine where we are in the cycle of customer closures, not to mention how long they will persist and at what level they will return. Due to the uncertainty regarding the overall severity and duration of the pandemic and it's ultimate impact on our business, we are not providing guidance for the remainder of fiscal 2020 at this time. Although we are not able to provide guidance or quantify the future impact, we clearly expect the disruption related to this pandemic will have a negative impact on our revenues and profitability. We also expect that, if sustained for an extended period, the sharp decline in oil prices as well as the decline in the Canadian exchange rate will further challenge our performance.
With respect to the second quarter results, revenues and profits were mostly within our expectations. Consolidated second quarter revenues were $464.6 million, an increase of 6.2% over the same quarter a year ago. Meanwhile, non-GAAP adjusted operating income and net income were $44.1 million and $34.7 million respectively, representing increases of 6.8% and 8.2% when compared to the second quarter of last year.
Organic growth for our Core Laundry operations decelerated sequentially as expected and discussed in our first quarter earnings call. New sales activity, as well as net additions versus reductions lagged the second quarter of a year ago, which was a historically strong new sales quarter. Throughout the quarter, we continued to see weakness in the energy dependent markets that we service which can be attributed to the slower growth.
Year-to-date, through February, we have generated significant free cash flows. At the end of the quarter, we have almost $400 million in cash and cash equivalents on our books with no debt. As a result, we believe we are well-positioned to deal with the adversity we are facing related to this coronavirus pandemic. And with that, I'd like to turn the call over to Shane, who will provide details on the results of our second quarter.
Shane F. O'Connor -- Senior Vice President and Chief Financial Officer
Thanks, Steve. As Steve mentioned, consolidated revenues in our second quarter of 2020 were $464.6 million, up 6.2% from $437.5 million a year ago and consolidated operating income decreased to $44.1 million from $62.4 million or 29.3%. Net income for the quarter decreased to $34.7 million or $1.82 per diluted share from $47.6 million or $2.48 per diluted share. As a reminder, operating income and net income in last year's second quarter, both benefited from a pre-tax gain of $21.1 million. This gain related to a settlement, we entered into with the lead contractor for a version of the CRM system, which we recorded, a $55.8 million impairment charge for, in fiscal 2017. This settlement included the receipt of a one-time cash payment of $13 million, the forgiveness of amounts previously due the contractor, as well as the receipt of certain hardware and related maintenance.
Excluding the effect of the CRM related settlement, consolidated operating income and net income increased from prior year's adjusted amounts by 6.8% and 8.2% respectively and diluted EPS increased 9% from prior year's adjusted amount of $1.67.
Our Core Laundry operations revenues for the quarter were $412.2 million, up 4.5% from the second quarter of 2019. Core Laundry organic growth which adjusts for the estimated effective acquisitions as well as fluctuations in the Canadian dollar was 3.6%. During the quarter, our organic growth continued to benefit from solid new account sales and improved customer retention in fiscal 2019, as well as the improved collection of merchandise recovery charges. Core Laundry revenues were negatively impacted by approximately 0.3% from the timing of revenues around the Thanksgiving holiday. Core Laundry operating income was $38.4 million for the quarter, down from $59.1 million in the prior year and the segment's operating margin decreased to 9.3% from prior year's 15%. Adjusting for the effect of the CRM related settlement, adjusted operating income in 2019 would have been $38.0 million or 9.6% of revenues. The decrease from prior year's adjusted operating margin was primarily due to higher production and service payroll costs as a percentage of revenues. These higher amounts were partially offset by lower energy costs, which decreased to 4.1% of revenues in the second quarter of 2020 from 4.3% in prior year.
Revenues from our Specialty Garments segment, which deliver specialized nuclear decontamination and cleanroom products and services increased to $36.0 million from $29.8 million in prior year or 21%. This decrease was largely due to higher direct sale activity in the quarter, as well as strong growth in our cleanroom and the European nuclear operations. The segment's operating margin increased to 12.9% or $4.6 million from 7.5% or $2.2 million in the year ago period. This increase was primarily due to the higher direct sale activity in the quarter. As we've mentioned in the past, this segment's results can vary significantly from period to period due to seasonality and the timing of nuclear reactor outages and projects that require our specialized services.
Our First Aid segment's revenues increased to $16.4 million from $13.3 million in prior year or 23.2%. This increase was primarily due to a strong quarterly performance in the segment's wholesale distribution business as well as the company's initiative to expand its First Aid van business into new geographies. Operating income increased 4.1% compared to prior year, while operating margin decreased to 7% from 8.2% in 2019. The decrease in operating margin was primarily attributable to higher selling and casualty claims expense during the quarter.
We continue to maintain a solid balance sheet and financial position with no long term debt and cash, cash equivalents and short term investments totaling $395.3 million at the end of our second quarter of fiscal 2020. Cash provided by operating activities for the first half of the fiscal year was $136.9 million, an increase of $8.2 million from the comparable period in prior year.
For the first half of fiscal 2020, capital expenditures totaled $62.3 million as we continue to invest in our future with new facility additions, expansions, updates and automation systems. As we look forward toward the second half of our fiscal year, our capex rate will be impacted by our responses to the uncertainty around the coronavirus pandemic. At this time, we have placed all growth related expenditures that are practical to suspend on hold until we have more clarity as to the severity and longevity of this pandemic's impact on our operations.
During the quarter, we capitalized $2.8 million related to our ongoing CRM project which consisted of license fees, third-party consulting costs and capitalized internal labor costs. In the first half of our fiscal year, we have capitalized a total of $6.2 million related to this project. We do not expect to suspend this important strategic initiative due to the coronavirus pandemic and remain hopeful that sometime in the second half of this fiscal year, we will begin piloting at select locations. As a reminder, we do not expect to incur any depreciation expense related to this project in fiscal 2020.
During the second quarter of fiscal 2020, we repurchased 20,500 common shares for a total of $4.2 million under our previously announced stock repurchase program. As of February 29, 2020, we had repurchased a total of 268,250 common shares for a total of $44.7 million under the program. This concludes our prepared remarks and we would now be happy to answer any questions that you may have.
Questions and Answers:
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Andrew Steinerman with J.P. Morgan. Please go ahead.
Andrew Steinerman -- J.P. Morgan -- Analyst
Good morning. Are you able to give us a sense of your decremental margins, should your revenue growth decline during this outbreak period?
Steven S. Sintros -- President and Chief Executive Officer
Andrew, that's not a question that we're prepared to quantify at this point. And I think, as you can imagine, it depends a lot on the depth of the decline and how quick the decline comes. I think the decline we are seeing is something like we've never experienced compared to, for example, the recession in 2008 or 2009 where companies slowly laid off employees or, I shouldn't say slowly, but more slowly laid off employees, as the economy faltered. Right now, we're seeing more significant sharp declines in revenues due to customer closures and we really have to evaluate as a company, how aggressively we want to work with our cost structure during that time.
And I think it's going to take us a little time to evaluate the depths in severity as well as the duration that we think we're going to be experiencing this. Because during a shorter period, we would not want to take actions that are too aggressive to restructure significantly our route structure or unwind some of our sales force or some of the other things that would be more difficult to bring back quickly. So at this point, we're still in evaluation mode, trying to get our arms around the depth of what we're going to be experiencing and how long and we'll be working through those plants.
Andrew Steinerman -- J.P. Morgan -- Analyst
And then if I could just -- could I just go back to the Great Recession, just ask one question on that. Could you just give us a sense, really a reminder of why it feels like your business was dragged in the Great Recession on a delayed basis? What I mean is the Great Recession ended in June of 2009, but it wasn't really until your fiscal '10 did you see organic revenue growth decline and it was only slightly, but it really feels like 2010 fiscal was more dragged than 2009 fiscal. Why was that kind of delayed response and, of course, my question is, do you feel like there might be a delay here as well?
Steven S. Sintros -- President and Chief Executive Officer
The short answer is, Andrew, that as customers during 2009 laid off employees, it has the impact of sort of layering on top of each other. So for example, the first two quarters of 2009, although customers were laying off employees, our revenues had still not yet dropped below the prior year. We were still showing growth. It wasn't till the cumulative effect of those layoffs took hold later in 2009, that you sort of went into 2010 with the lower billing -- a lower weekly billing rate and you start showing year-over-year declines in revenues, like you said, albeit slightly. But that's really where the challenges -- that's really where the challenge starts when you start having quarters where your revenues are below the year before.
The thing that makes this so different, and I don't think there will be that similarity, is that, you know for mostly, what we're seeing, it's less of an issue of employers laying off employees at least right now. Businesses are just being closed down and quite frankly, we don't even have true visibility as to what's going behind the scenes with those companies. Are they laying off all those employees? Will they come back? If they do come back, at what rate will they come back? So, I think for this environment we're in, we're going to see a sharper impact quicker and then it remains to be seen what that ongoing impact is like, depending on the duration and how many of these companies can get their operations back going again when there is an eventual recovery, depending on when that is.
Andrew Steinerman -- J.P. Morgan -- Analyst
Thank you. Appreciate it.
Steven S. Sintros -- President and Chief Executive Officer
Thank you.
Operator
Our next question comes from the line of Andrew Wittmann with Baird. Please go ahead.
Andrew Wittmann -- R.W. Baird -- Analyst
Yeah, great thanks. Good morning, guys. I had several questions or few questions here. Just I think that will be helpful for you to talk about specifically kind of trying to understand your customer mix a little bit better and there is a couple of different ways that I was hoping you could address that. In particular, maybe first, can you talk about as a percentage of your revenue, how much of your business is driven by national accounts versus medium-sized accounts and then maybe the small accounts, recognizing that you service all of those customers?
And maybe in your response to that, could you also just talk about some of those most heavily impacted areas? What kind of exposure do you have maybe to restaurant and hospitality? And then you specifically mentioned oil and gas. I think, kind of, those are the areas that I think a lot of people are focused on, maybe there are others that like maybe you'd want to highlight, but I think giving some context around those things would be helpful for everyone on the call.
Steven S. Sintros -- President and Chief Executive Officer
No, that makes sense, Andy. So when you look at our customer base, just to give you a sense, we talk about 15% to 20% of our business being in national accounts, either exclusive national accounts or preferred provider relationship, so it's in that 15%, 20% range. The number probably goes a little higher than that if you include some larger, maybe regional accounts, but it's in that ballpark, which obviously, the inverse of that, is that a relatively high percent is small to mid-sized local businesses.
When you look at the sort of SIC breakdown, I'll give you a few of those touch points you were asking for. The SIC for eating and drinking places is about 6.5%, so that's mostly restaurants, some hospitality. We don't do a lot of pure hospitality and the energy is about 5% these days. When you look at some of the other big areas just to round it out, we have about 17% in manufacturing, about 16% in auto-related but that auto-related is car dealerships, it's some manufacturing, it's gas stations, it's a lot of repair shops. We have about 8% in food stores, in food manufacturing. That's obviously an area that is going strong right now and being challenged with the volumes that they are actually dealing with. And then we have about 4% in healthcare as well. So we do, do some healthcare-related customers, not as much the big bulk hospital work, but more some facility service work in hospitals as well as other sort of, what we call, retail medical clinics and places where you might get your MRI or blood drawn and things like that around the country.
So we're seeing really a mixed bag around the country. I think what's probably helpful for the listeners is to understand what we're seeing out there. In terms of revenue decline, we're sort of hesitant to provide any discrete numbers, but really as of two weeks ago, that's last week and the week before -- before that we really hadn't seen any revenue declines. The first week, we saw a modest revenue decline and last week, we saw a sharper decline as many of the states started to shutter non-essential businesses. And our billing last week -- and again, I'm giving you this number cautiously because it's not meant to be thought as the bottom or even a 100% accurate number but directionally, our billing last week was down about 12% from our February average. So that just gives you a first line look at what we're experiencing.
We continue to field calls around businesses closing and we also continue to see states, some of which who haven't put in as stringent guidelines yet in terms of what the central businesses and what aren't -- ramp that up. So we expect some states to sort of catch-up. So right now it's very much a geographic issue. For example in the Northeast, up in New Hampshire and Vermont where we service ski areas and a little bit more hospitality and restaurants, we're down quite a bit more than that 12%. But there are markets that haven't taken as stringent actions yet that we're down quite a bit less than that 12%.
So that's where we are today. But again, we really want to caution when we give out that directional number that we know more is coming. And it goes without saying that the length and duration and recovery is just very unknown at this point.
Andrew Wittmann -- R.W. Baird -- Analyst
That's really helpful, Steve. I guess, I think, the natural question that comes out of your response there is maybe some comments from you on the contract structures. I mean, you do have contracts with these customers. There is a lot of, I don't know, give and take, I think, with the customer relationships that you have. I mean, these are real relationships where you see them every week and some of these customers you've had for a long time, so I understand that maybe not every contract gets enforced to the letter of the contract. But can you just talk about how you're dealing with some of these business closures? I mean, I think, technically, are they contractually obligated to you and how are you going through those and maybe some perspective there would be helpful for everyone too?
Steven S. Sintros -- President and Chief Executive Officer
I'll be honest with you, Andy. For the most part, the businesses that are closed down, we are not pushing billing through. I think we're trying to be a good partner during these difficult times. And we're working with those customers, particularly the larger customers, but the smaller customers as well with the idea being that we're not sacrificing the length of the contract during this time that they're closed. But the last thing we want to be doing this time is alienating customers that are going through a very difficult time as well as billing customers that may not be able to pay anytime soon or even longer than that, depending on the strength of their business.
So we are trying to work on it a little bit, customer by customer, but I'll be honest, we're not being overly aggressive in that regard. As you know, most of our customers -- and you're right, a lot of these relationships, particularly the local relationships and contracts, are left up to a little bit of ongoing negotiation with the customers as costs go up. You know, we are able to put through price increases in tough times. Quite frankly, we have a lot of customers coming to us, as you can imagine, saying, what can you do for me in terms of price concessions or other concessions. So we're trying to work through it as organized as we can with the customer base, but at the level of closures that are going on right now, it's challenging even to connect with all of those customers in a real-time. So we're working through it. I think we're trying to do the best we can to preserve the long term relationships with these customers and to also help them weather these tough times.
Andrew Wittmann -- R.W. Baird -- Analyst
Well, that's great. Really helpful, again. I just have one kind of last question, and I understand the differences between this time and 2009. I think those are pretty obvious to most people, but one of the things that comes up, as I think back to 2009, 2010 and, like Andrew kind of mentioned in his question, your revenues were down, but maybe not as much as peers. Can you talk about -- I don't know if there is a strategic decision that the company was making that time to go low on price or other things that helps you mitigate the revenue declines for your company. Just to have some perspective on that one.
Steven S. Sintros -- President and Chief Executive Officer
Yeah, back in 2009?
Andrew Wittmann -- R.W. Baird -- Analyst
Yeah, back in 2009. It's helpful to have some perspective because I also think that energy prices were kind of pulling you guys higher out of 2009, it was a contributor to the positives there as well.
Steven S. Sintros -- President and Chief Executive Officer
That's right. So I think during 2009, we were going through a little bit of a transformation and reinvestment in our sales force. We talked about national accounts. Back -- and I may not have the numbers exactly right, but back in 2007, 2008, our national account presence was relatively small. It was less than 10%, probably 7% or 8%. And so we had started kind of building our national account sales engine. We had invested a lot in local sales development over those years as well. And I think we really sort of hit the ground running and also did not, during that time, trim the sales force because we were actually in the process of growing it and continue to sort of sell through those challenges. And so I think that definitely helped us during that time.
And then I think you referred to as oil prices rebounded pretty quickly coming out of that time period, that transition, not only to increased energy exploration activity, but the conversion at that time with many customers, not only in the energy sector that had to convert to flame-resistant garments helped as well. So I think we've talked about before in the past when they were renting maybe cotton garments, you were getting a certain price a week and then the flame-resistant garments. So it wasn't only an increase in activity, but it was an increase in the cost of the garments and therefore demanding a higher price from those services. So that all contributed to that time.
But you're right, the key to maintaining and actually improving margins during that time was the fact that the revenue never really backed up in a significant way. I think you understand our infrastructure enough to know that if you're down 10%, 12%, 15% or whatever it might land at, there are practical challenges in pulling that cost structure in, particularly over the short term. If that were to persist, then I think moves would need to be made to right-size the cost structure. It's just a shock to the system right now and the economy, that this is all happening very quickly and we'll have to make those decisions to best keep in mind the long term of the company.
Andrew Wittmann -- R.W. Baird -- Analyst
Great, thanks.
Steven S. Sintros -- President and Chief Executive Officer
Thank you.
Operator
Our next question comes from the line of Tim Mulrooney with William Blair. Please go ahead.
Tim Mulrooney -- William Blair -- Analyst
Good morning, Steve. Good morning. Shane.
Steven S. Sintros -- President and Chief Executive Officer
Good morning.
Tim Mulrooney -- William Blair -- Analyst
So just a couple of follow-ups on these guys questions. I know Andy's question on the decrementals was hard. If you guys can't frame the decrementals for us, maybe you could just talk about your cost structure in a little more detail. How much of cost of goods sold do you consider to be variable costs and how much of your SG&A do you consider to be variable versus fixed?
Steven S. Sintros -- President and Chief Executive Officer
So I will take you through the P&L a little bit, Tim and give you some color there. And these aren't a 100% spot on numbers, but they're directionally accurate. So they sort of give you an idea. When you look at our cost of revenues, there are three primary categories that make up those cost of revenues, merchandise, production cost, which is really the cost to run the facilities, and then service cost -- service and delivery costs.Those three pieces, and again I'm using very round numbers. Let's say, they're all, one-third, one-third, one-third of your 60% or so cost of revenues.
So merchandise will trend with the volume. Over time, if volume contracts, the demand for the garments will come down for sure. Okay? When you get into the other categories, it's more of a mix.
Production, there are a lot of variable cost in production in terms of the labor and the supplies to run those facilities. But there is some portion of those costs and I'm not going to give a percent that are more fixed in terms of the facilities themselves, rents, real estate, taxes and those type of things. So there is an element of fixed and variable in there, but probably a little bit more on the variable side in your production costs.
When you get to your service and route structure, that's where it gets a lot more complicated. You know, it really depends on the level of decline. Is the decline in such a way that you can easily take routes off the road? Do you want to take routes off the road if we feel like this business is going to come back? So over the long term, a lot of your service costs are variable but that gets back to how much you want to scale that down in the short term only to have to put that back in place because that is not an easy structure to quickly flex up and down. And so we would be hesitant there in the short term to kind of pull that structure apart.
When you get into your SG&A, I'll start with the sales side. We have a large sales force that's trained and ready to go. And that's also not something that we necessarily want to scale back on significantly when an eventual recovery would require that sales force more than ever to continue to drive that volume growth back up. Now, again, you can make the decision to trim sales whenever you want, but it's going to have an impact on your ability to drive volumes. And then on the G&A side, I think you know there is a mixed bag there as well. It sort of depends on projects and initiatives that you want to continue to work on. Eventually, you can right-size some of that G&A, but it's a challenge. And depending on how things get, there are steps we can take there that I'm sure a lot of companies are considering and instituting to try to trim costs there in the short term, while not disrupting or pulling apart your team. So hopefully that gives you a general idea of the different categories and the way we're looking at it.
Tim Mulrooney -- William Blair -- Analyst
No, that's very helpful, Steve. Thanks for walking us through that. If I can shift gears here, I'm -- well, first, let me build on Andrew's question. When you say that you aren't sacrificing the lengths of the contract while the customers close, should we interpret that as essentially the duration of the length of the contract is extended for the period of time that the customers are closed down?
Steven S. Sintros -- President and Chief Executive Officer
Generally, our contracts allows for that. Again, it's not something that on a large-scale basis, we've sort of had to enact. But yes, I think those are the types of conversations you'll have with customers and I think for the most part, they are more than willing to work with you on. So you know, again if it's a matter of weeks, it's not a large deal either way, our goal is to renew those contracts in the normal course. If they are closed for longer than that, then I think you start to get in these conversations about if a business is closed for, say, four months, what really is the status of that business when it opens back up. And so we really don't know how these are going to transpire, but we expect to be working through them over the course of the spring and the summer.
Tim Mulrooney -- William Blair -- Analyst
Okay, thank you. Lastly, on capital allocation. Can you just talk about if you're -- if and how your priorities have changed? You gave some good color on capex, but could you also touch on some of the other items, maybe how you're thinking about the M&A environment, as well as your updated thoughts regarding the dividend and share repurchases? I mean your balance sheet is obviously in great shape here so that would be helpful.
Steven S. Sintros -- President and Chief Executive Officer
Yeah, right now, we're taking a little bit of a wait-and-see approach to make any major changes or decisions. We continue with the dividend right now, for sure. As far as M&A goes, there's really not much going on right now. We will certainly keep our eyes open if this environment causes any sellers to consider their options, given some of the difficulties and challenges and we'd be willing to look at those opportunities for sure. In terms of share buybacks, that's also something we'll continue to evaluate. I think at this time, you're right, we have a lot of cash on hand, but we're still in the very early stages of trying to determine what the business is going to look like over the next quarter or two. And we'll just have to evaluate that as we go and part of that evaluation will be stock reaction and cash generation and potential for share buybacks. So that will be at the forefront of what we're evaluating.
Tim Mulrooney -- William Blair -- Analyst
Okay, thank you. Good luck to the team.
Steven S. Sintros -- President and Chief Executive Officer
Thank you.
Operator
We have no further questions at this time.
Steven S. Sintros -- President and Chief Executive Officer
Well, thank you, everyone for participating in the call. We look forward to speaking with you again in a few months when we'll be updating you on our third quarter results. Thank you. Have a great day and everyone please be safe.
Operator
[Operator Closing Remarks]
Duration: 36 minutes
Call participants:
Steven S. Sintros -- President and Chief Executive Officer
Shane F. O'Connor -- Senior Vice President and Chief Financial Officer
Andrew Steinerman -- J.P. Morgan -- Analyst
Andrew Wittmann -- R.W. Baird -- Analyst
Tim Mulrooney -- William Blair -- Analyst
