Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Business Overview
UniFirst Corporation, together with its subsidiaries, hereunder referred to as “we”, “our”, the “Company”, or “UniFirst”, is one of the largest providers of workplace uniforms and protective work wear clothing in the United States. We design, manufacture, personalize, rent, clean, deliver, and sell a wide range of uniforms and protective clothing, including shirts, pants, jackets, coveralls, lab coats, smocks, aprons and specialized protective wear, such as flame resistant and high visibility garments. We also rent and sell industrial wiping products, floor mats, facility service products and other non-garment items, and provide restroom and cleaning supplies and first aid cabinet services and other safety supplies as well as provide certain safety training, to a variety of manufacturers, retailers and service companies.
We serve businesses of all sizes in numerous industry categories. Typical customers include automobile service centers and dealers, delivery services, food and general merchandise retailers, food processors and service operations, light manufacturers, maintenance facilities, restaurants, service companies, soft and durable goods wholesalers, transportation companies, healthcare providers, and others who require employee clothing for image, identification, protection or utility purposes. We also provide our customers with restroom and cleaning supplies, including air fresheners, paper products, gloves, masks, hand soaps and sanitizers.
At certain specialized facilities, we also decontaminate and clean work clothes and other items that may have been exposed to radioactive materials and service special cleanroom protective wear and facilities. Typical customers for these specialized services include government agencies, research and development laboratories, high technology companies and utilities operating nuclear reactors.
Headquartered in Wilmington, Massachusetts, UniFirst Corporation (NYSE: UNF) is a North American leader in the supply and servicing of uniform and workwear programs, as well as the delivery of facility service programs. Together with its subsidiaries, the Company also provides first aid and safety products, and manages specialized garment programs for the cleanroom and nuclear industries. UniFirst manufactures its own branded workwear, protective clothing, and floorcare products; and with 260 service locations, over 300,000 customer locations, and 14,000 employee Team Partners, the Company outfits more than 2 million workers each business day. For more information, contact UniFirst at 800.455.7654 or visit UniFirst.com. U.S. GAAP establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information of those segments to be presented in interim financial reports issued to shareholders. Operating segments are identified as components of an enterprise for which separate discrete financial information is available for evaluation by the chief operating decision-maker, or decision-making group, in making decisions on how to allocate resources and assess performance. Our chief operating decision-maker is our Chief Executive Officer. We have six operating segments based on the information reviewed by our Chief Executive Officer: U.S. Rental and Cleaning, Canadian Rental and Cleaning, Manufacturing (“MFG”), Specialty Garments Rental and Cleaning (“Specialty Garments”), First Aid and Corporate. The U.S. Rental and Cleaning and Canadian Rental and Cleaning operating segments have been combined to form the U.S. and Canadian Rental and Cleaning reporting segment. Refer to Note 15, “Segment Reporting”, of our Consolidated Financial Statements for our disclosure of segment information.
The U.S. and Canadian Rental and Cleaning reporting segment purchases, rents, cleans, delivers and sells, uniforms and protective clothing and non-garment items in the United States and Canada. The operations of the U.S. and Canadian Rental and Cleaning reporting segment are referred to by us as our ‘industrial laundry operations’ and we refer to the locations related to this reporting segment as our ‘industrial laundries’.
The MFG operating segment designs and manufactures uniforms and non-garment items primarily for the purpose of providing these goods to the U.S. and Canadian Rental and Cleaning reporting segment. The amounts reflected as revenues of MFG are primarily generated when goods are shipped from our manufacturing facilities, or subcontract manufacturers, to our other locations. These intercompany revenues are recorded at a transfer price which is typically in excess of the actual manufacturing cost. Products are carried in inventory and subsequently placed in service and amortized at this transfer price. On a consolidated basis, intercompany MFG revenues and MFG income are eliminated and the carrying value of inventories and rental merchandise in service is reduced to the manufacturing cost. Income before income taxes from MFG, net of the intercompany MFG elimination, offsets the merchandise amortization costs incurred by the U.S. and Canadian Rental and Cleaning reporting segment as the merchandise costs of this reporting segment are amortized and recognized based on inventories purchased from MFG at the transfer price which is above our manufacturing cost.
The Corporate operating segment consists of costs associated with our distribution center, sales and marketing, information systems, engineering, materials management, manufacturing planning, finance, budgeting, human resources, other general
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and administrative costs and interest expense. The revenues generated from the Corporate operating segment represent certain direct sales made directly from our distribution center. The products sold by this operating segment are the same products rented and sold by the U.S. and Canadian Rental and Cleaning reporting segment. In the segment disclosures in Note 15, “Segment Reporting”, of our Consolidated Financial Statements, no assets or capital expenditures are presented for the Corporate operating segment as no assets are allocated to this operating segment in the information reviewed by our chief executive officer. However, depreciation and amortization expense related to certain assets are reflected in income from operations and income before income taxes for the Corporate operating segment. The assets that give rise to this depreciation and amortization are included in the total assets of the U.S. and Canadian Rental and Cleaning reporting segment as this is how they are tracked and reviewed by us.
We refer to our U.S. and Canadian Rental and Cleaning, MFG, and Corporate segments combined as our “Core Laundry Operations”.
The Specialty Garments operating segment purchases, rents, cleans, delivers and sells, specialty garments and non-garment items primarily for nuclear and cleanroom applications and provides cleanroom cleaning services at limited customer locations. The First Aid operating segment sells first aid cabinet services and other safety supplies as well as maintains wholesale distribution and pill packaging operations.
Approximately 89% of our revenues in fiscal 2020 were derived from U.S. and Canadian Rental and Cleaning and Corporate. A key driver of this business is the number of workers employed by our customers. Our revenues are directly impacted by fluctuations in these employment levels. Revenues from Specialty Garments, which accounted for approximately 7% of our 2020 revenues, increase during outages and refueling by nuclear power plants, as garment usage increases at these times. First Aid represented approximately 4% of our total revenue in fiscal 2020.
Critical Accounting Policies and Estimates
We believe the following critical accounting policies reflect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements.
Use of Estimates
We prepare our financial statements in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. We utilize key estimates in preparing the financial statements, including casualty and environmental estimates, recoverability of goodwill, intangibles, income taxes and long-lived assets. These estimates are based on historical information, current trends, and information available from other sources. Our results are affected by economic, political, legislative, regulatory and legal actions. Economic conditions, such as recessionary trends, inflation, interest and monetary exchange rates, government fiscal policies, government policies surrounding the containment of COVID-19 and changes in the prices of raw materials, can have a significant effect on operations. These factors and other events could cause actual results to differ from management's estimates.
Revenue Recognition and Allowance for Doubtful Accounts
We recognize revenue from rental operations and related services in the period in which the services are provided. Direct sale revenue is recognized in the period in which the services are performed or when the product is shipped. Our judgment and estimates are used in determining the collectability of accounts receivable and evaluating the adequacy of the allowance for doubtful accounts as well as our sales credits reserve. We consider specific accounts receivable and historical bad debt experience, customer credit worthiness, current economic trends and the age of outstanding balances as part of our evaluation in assessing the allowance for doubtful accounts. We consider our historical credit experience in assessing the sales credits reserve. Changes in our estimates are reflected in the period they become known. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Material changes in our estimates may result in significant differences in the amount and timing of bad debt expense recognition for any given period. Our revenues do not include taxes we collect from our customers and remit to governmental authorities.
Costs to Obtain a Contract
We defer commission expenses paid to employee-partners when the commissions are deemed to be incremental for obtaining the route servicing customer contract. The deferred commissions are amortized on a straight-line basis over the expected period of benefit, which is generally the estimated life of the customer relationship. We review the deferred commission
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balances for impairment on an ongoing basis. Deferred commissions are classified as current or noncurrent based on the timing of when we expect to recognize the expense. The current portion is included in prepaid expenses and other current assets and the non-current portion is included in other assets on our consolidated balance sheets. As of August 29, 2020, the current and non-current assets related to deferred commissions totaled $ 13.3 million and $ 55.6 million, respectively. As of August 31, 2019, the current and non-current assets related to deferred commissions totaled $12.4 million and $50.3 million, respectively. During fiscal 2020 and 2019, we recorded $13.7 million and $11.8 million, respectively, of amortization expense related to deferred commissions. This expense is classified in selling and administrative expenses on the consolidated statements of income.
Inventories and Rental Merchandise in Service
Our inventories are stated at the lower of cost or net realizable value, net of any reserve for excess and obsolete inventory. Judgments and estimates are used in determining the likelihood that new goods on hand can be sold to our customers or used in our rental operations. Historical inventory usage and current revenue trends are considered in estimating both excess and obsolete inventories. If actual product demand and market conditions are less favorable than the amount we projected, additional inventory write-downs may be required. We use the first-in, first-out method to value our inventories, which primarily consist of finished goods. Rental merchandise in service is being amortized on a straight-line basis over the estimated service lives of the merchandise, which range from six to thirty-six months. In establishing estimated lives for merchandise in service, our management considers historical experience and the intended use of the merchandise. Material differences may result in the amount and timing of operating profit for any period if we make significant changes to our estimates.
Goodwill, Intangibles and Other Long-Lived Assets
In accordance with U.S. GAAP, we do not amortize goodwill. Instead, we test goodwill at the reporting unit level for impairment on an annual basis and between annual tests if events and circumstances indicate it is more likely than not that the fair value of a reporting unit is less than its carrying value. Our evaluation considers changes in the operating environment, competitive information, market trends, operating performance and cash flow modeling.
We completed our annual goodwill impairment test as of the first day of the fourth quarter in fiscal 2020 and the last day of the fourth quarter of each fiscal year in fiscal 2019 and 2018. There have been no impairments of goodwill or other intangible assets in fiscal 2020, 2019 and 2018.
We cannot predict future economic conditions and their impact on the Company or the future net realizable value of our stock. A decline in our market capitalization and/or deterioration in general economic conditions could negatively and materially impact our assumptions and assessment of the fair value of our business. If general economic conditions or our financial performance deteriorate, we may be required to record a goodwill impairment charge in the future which could have a material impact on our financial condition and results of operations.
Property, plant and equipment, and definite-lived intangible assets are depreciated or amortized over their useful lives. Useful lives are based on our estimates of the period that the assets will generate economic benefits. Long-lived assets are evaluated for impairment whenever events or circumstances indicate an asset may be impaired. There were no material impairments of long-lived assets in fiscal 2020, 2019, and 2018.
Insurance
We self-insure for certain obligations related to healthcare, workers’ compensation, vehicles and general liability programs. We also purchase stop-loss insurance policies for workers’ compensation, vehicles and general liability programs to protect ourselves from catastrophic losses. Judgments and estimates are used in determining the potential value associated with reported claims and for events that have occurred but have not been reported. Our estimates consider historical claim experience and other factors. Our liabilities are based on our estimates, and, while we believe that our accruals are adequate, the ultimate liability may be significantly different from the amounts recorded. In certain cases where partial insurance coverage exists, we must estimate the portion of the liability that will be covered by existing insurance policies to arrive at our net expected liability. Receivables for insurance recoveries are recorded as assets, on an undiscounted basis. Changes in our claim experience, our ability to settle claims or other estimates and judgments we use could have a material impact on the amount and timing of expense for any given period.
Environmental and Other Contingencies
We are subject to legal proceedings and claims arising from the conduct of our business operations, including environmental matters, personal injury, customer contract matters and employment claims. U.S. GAAP requires that a liability for
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contingencies be recorded when it is probable that a liability has occurred, and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence of a liability, as well as the amount to be recorded. We regularly consult with our attorneys and outside consultants, in our consideration of the relevant facts and circumstances, before recording a contingent liability. We record accruals for environmental and other contingencies based on enacted laws, regulatory orders or decrees, our estimates of costs, insurance proceeds, participation by other parties, the timing of payments, and the input of our attorneys and outside consultants.
The estimated liability for environmental contingencies has been discounted as of August 29, 2020 using risk-free interest rates ranging from 0.7% to 1.5% over periods ranging from ten to thirty years. The estimated current costs, net of legal settlements with insurance carriers, have been adjusted for the estimated impact of inflation at 3.0% per year. Changes in enacted laws, regulatory orders or decrees, our estimates of costs, risk-free interest rates, insurance proceeds, participation by other parties, the timing of payments, the input of our attorneys and outside consultants or other factual circumstances could have a material impact on the amounts recorded for our environmental and other contingent liabilities. Refer to Note 11, “Commitments and Contingencies”, of our Consolidated Financial Statements for additional discussion and analysis.
Asset Retirement Obligations
Under U.S. GAAP, asset retirement obligations generally apply to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset. Current accounting guidance requires that we recognize asset retirement obligations in the period in which they are incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset.
We have recognized as a liability the present value of the estimated future costs to decommission our nuclear laundry facilities in accordance with U.S. GAAP. We depreciate, on a straight-line basis, the amount added to property, plant and equipment and recognize accretion expense in connection with the discounted liability over the various remaining lives which range from approximately one to twenty-five years.
Our estimated liability has been based on historical experience in decommissioning nuclear laundry facilities, estimated useful lives of the underlying assets, external vendor estimates as to the cost to decommission these assets in the future, and federal and state regulatory requirements. The estimated current costs have been adjusted for the estimated impact of inflation at 3% per year. The liability has been discounted using credit-adjusted risk-free rates that range from approximately 7.0% to 7.5%. Revisions to the liability could occur due to changes in the estimated useful lives of the underlying assets, estimated dates of decommissioning, changes in decommissioning costs, changes in federal or state regulatory guidance on the decommissioning of such facilities, or other changes in estimates. Changes due to revisions in our estimates will be recognized by adjusting the carrying amount of the liability and the related long-lived asset if the assets are still in service, or charged to expense in the period if the assets are no longer in service.
Supplemental Executive Retirement Plan and other Pension Plans
We recognize pension expense on an accrual basis over our employees’ estimated service periods. Pension expense is generally independent of funding decisions or requirements.
The calculation of pension expense and the corresponding liability requires us to use a number of critical assumptions, including the expected long-term rates of return on plan assets, the assumed discount rate, the assumed rate of compensation increases and life expectancy of participants. Changes in our assumptions can result in different expense and liability amounts, and future actual expense can differ from these assumptions. Pension expense increases as the expected rate of return on pension plan assets decreases. Future changes in plan asset returns, assumed discount rates and various other factors related to the participants in our pension plans will impact our future pension expense and liabilities. We cannot predict with certainty what these factors will be in the future.
Income Taxes
We compute income tax expense by jurisdiction based on our operations in each jurisdiction. Our effective tax rate differs from the statutory U.S. income tax rate due to the effect of varying state and local income taxes, tax rates in foreign jurisdictions, tax credits, and certain nondeductible expenses.
Deferred income taxes are provided for temporary differences between the amounts recognized for income tax and financial reporting purposes at currently enacted tax rates. Deferred income taxes are classified as assets or liabilities based on the classification of the related asset or liability for financial reporting purposes. We review deferred tax assets for recoverability based upon projected future taxable income and the expected timing of the reversals of existing temporary differences.
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Although realization is not assured, management believes it is more likely than not that the recorded deferred tax assets will be realized.
We are periodically reviewed by U.S. domestic and foreign tax authorities regarding the amount of taxes due. These reviews typically include inquiries regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. Tax authorities may disagree with certain positions we have taken. In evaluating our exposure associated with various filing positions, we have recorded estimated reserves . Refer to Note 4, “Income Taxes”, of our Consolidated Financial Statements for further discussion regarding our accounting for income taxes and uncertain tax positions for financial accounting purposes.
COVID-19 Assessment
The outbreak of a novel strain of coronavirus (COVID-19) continues to impact a number of countries, including the United States, Canada, Mexico, Nicaragua and the European countries in which we operate. Developments continue to occur rapidly with respect to the spread of COVID-19 and its impact on human health and businesses. New and changing government actions to address the COVID-19 pandemic continue to occur on a daily basis. Our revenues in the second half of fiscal 2020 were significantly adversely impacted as a result of many customers closing their businesses or operating at limited capacities. Although many of our customers have reopened or increased their operating levels as government restrictions have begun to be lifted, our sales to many such customers are below their pre-pandemic levels and may not return to such pre-pandemic levels. In addition, although many of our customers reopened or increased their operating levels, such customers may again be forced to close or limit operations as any new COVID-19 outbreaks occur. Any such closures or reductions in operating levels could have a significant adverse impact on our business. At times during the pandemic, we have also experienced supply chain disruptions with respect to certain products, including hand sanitizer and masks. Such disruptions continue to occur, but have moderated to some extent more recently.
We remain focused on the safety and well-being of our team partners and on the service of our customers. We will continue to review and assess the rapidly-changing COVID-19 pandemic and its impacts on our team partners, our customers, our suppliers and our business so that we can seek to address the impacts on our business and service our customers.
Because developments with respect to the spread of COVID-19 and its impacts continue to occur so rapidly, and because of the unprecedented nature of the pandemic, we are unable to predict the extent and duration of the adverse impact of COVID-19 on our business, financial condition and results of operations.
We have assessed the current impact of COVID-19 on our consolidated financial condition, results of operations, and cash flows, as well as our estimates and accounting policies. We have made additional disclosures of these assessments, as necessary. Given the unprecedented nature of this situation, we cannot reasonably estimate the full extent of the impact COVID-19 will have on our consolidated financial condition, results of operations, and cash flows in the foreseeable future. The ultimate impact of COVID-19 on the Company is highly uncertain and will depend on future developments, and such impacts could exist for an extended period of time, even after the COVID-19 pandemic subsides.
As of August 29, 2020, our cash, cash equivalents, and short-term investments were $474.8 million, and we had access to $179.2 million of borrowing capacity under our $250 million unsecured revolving credit facility, which we believe will continue to help us manage the impacts of the COVID-19 pandemic on our business and address related liquidity needs.
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National, state and local governments have responded to the COVID-19 pandemic in a variety of ways, including, without limitation, by declaring states of emergency, restricting people from gathering in groups or interacting within a certain physical distance (i.e., social distancing), and in certain cases, ordering businesses to close or limit operations or people to stay at home. Although we have been permitted to continue to operate in all of the jurisdictions in which we operate, including in jurisdictions that have mandated the closure of certain businesses and we expect to be permitted to continue to operate under any orders or other restrictions imposed by any government authorities in the future, there is no assurance that we will be permitted to operate under every future government order or other restriction and in every location. If we were to be subject to government orders or other restrictions on the operation of our business, we may be required to limit , or close, our operations at certain locations in the future. Any such limitations or closures could have a material adverse impact on our ability to service our customers and on our business, financial condition and results of operations. In particular, any limitations on, or closures of, our manufacturing facilities in Mexico or Nicaragua, or our distribution center in Owensboro, Kentucky, could have a material adverse impact on our ability to manufacture products and service customers and could have a material adverse impact on our business, financial condition and results of operations.
The COVID-19 pandemic has caused significant disruptions to our business and operations and could cause material disruptions to our business and operations in the future as a result of, among other things, quarantines, worker illness, worker absenteeism as a result of illness or other factors, social distancing measures and other travel, health-related, business or other restrictions. For similar reasons, the COVID-19 pandemic has also adversely impacted, and may continue to adversely impact, our suppliers and their manufacturers. Depending on the extent and duration of all of the above-described effects on our business and operations and the business and operations of our suppliers, our costs could increase, including our costs to address the health and safety of personnel, our ability to obtain products or services from suppliers may be adversely impacted, our ability to service certain customers could be adversely impacted and, as a result, our business, financial condition and results of operations could be materially adversely affected. In addition, depending on the extent and duration of the COVID-19 pandemic, we may be subject to significant increases in healthcare costs in the event that a significant number of our personnel become infected with COVID-19 and require medical treatment. As a result, any significant increases in healthcare costs as a result of COVID-19 or otherwise could have a material adverse impact on our business, financial condition and results of operations.
The COVID-19 pandemic has also resulted in material adverse economic conditions that are impacting, and may continue to impact, our business and the businesses of our suppliers and customers. Unemployment levels have increased significantly, and the U.S. economy has entered an economic recession. Some analysts have predicted that the current economic recession may persist for a significant period of time and become severe. Although the extent and duration of the impact of the COVID-19 pandemic on our business and operations and the business and operations of our customers and suppliers remain uncertain, the continued spread of COVID-19, the imposition of related public health measures and travel, health-related, business and other restrictions and the resulting materially adverse economic conditions may materially adversely impact our business, financial condition, results of operations and cash flows.
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Please see “Item 1A. Risk Factors” in this Annual Report on Form 10- K for an additional discussion of risks and potential risks of the COVID-19 pandemic on our business, financial condition and results of operations.
Results of Operations
The following table presents certain selected financial data, including the percentage of revenues represented by each item, for fiscal years 2020, 2019 and 2018.
% Change
(In thousands, except for percentages)
Fiscal
2020
% of
Revenues
Fiscal
2019
% of
Revenues
Fiscal
2018
% of
Revenues
Fiscal 2020
vs.
Fiscal 2019
Fiscal 2019
vs.
Fiscal 2018
Revenues
$
1,804,159
100.0
%
$
1,809,376
100.0
%
$
1,696,489
100.0
%
-0.3
%
6.7
%
Costs and expenses:
Cost of revenue (1)
1,164,932
64.6
1,139,195
63.0
1,056,724
62.3
2.3
7.8
Selling and administrative
expenses (1)
361,801
20.1
334,840
18.5
360,727
21.3
8.1
(7.2
)
Depreciation and amortization
104,697
5.8
103,333
5.7
96,662
5.7
1.3
6.9
1,631,430
90.4
1,577,368
87.2
1,514,113
89.2
3.4
4.2
Operating income
172,729
9.6
232,008
12.8
182,376
10.8
(25.6
)
27.2
Other income, net
(5,159
)
(0.3
)
(5,916
)
(0.3
)
(4,870
)
(0.3
)
(12.8
)
21.5
Income before income taxes
177,888
9.9
237,924
13.1
187,246
11.0
(25.2
)
27.1
Provision for income taxes
42,118
2.3
58,790
3.2
23,351
1.4
(28.4
)
151.8
Net income
$
135,770
7.5
%
$
179,134
9.9
%
$
163,895
9.7
%
(24.2
)%
9.3
%
(1)
Exclusive of depreciation on our property, plant and equipment and amortization of our intangible assets.
Revenues and income (loss) from operations by reporting segment for fiscal 2020, 2019, and 2018 are presented in the following table. Refer to Note 15, “Segment Reporting”, of our Consolidated Financial Statements for a discussion of our reporting segments.
Fiscal
Fiscal
Fiscal
(In thousands)
2020
2019
2018
Segment Information
Revenues
US and Canadian Rental and Cleaning
$
1,552,179
$
1,582,416
$
1,485,548
MFG
214,683
254,218
247,530
Net intercompany MFG elimination
(214,683
)
(254,111
)
(247,424
)
Corporate
49,306
33,682
37,994
Subtotal: Core Laundry Operations
1,601,485
1,616,205
1,523,648
Specialty Garments
133,185
132,767
118,477
First Aid
69,489
60,404
54,364
Total consolidated revenues
$
1,804,159
$
1,809,376
$
1,696,489
Operating income (loss)
US and Canadian Rental and Cleaning
$
247,392
$
235,046
$
213,322
MFG
64,097
84,248
89,035
Net intercompany MFG elimination
10,012
1,128
(9,658
)
Corporate
(171,514
)
(107,468
)
(129,111
)
Subtotal: Core Laundry Operations
149,987
212,954
163,588
Specialty Garments
17,845
14,145
14,070
First Aid
4,897
4,909
4,718
Total operating income
$
172,729
$
232,008
$
182,376
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General
We derive our revenues through the design, manufacture, personalization, rental, cleaning, delivering, and selling of a wide range of uniforms and protective clothing, including shirts, pants, jackets, coveralls, lab coats, smocks and aprons and specialized protective wear, such as flame resistant and high visibility garments. We also rent industrial wiping products, floor mats, facility service products, other non-garment items, and provide restroom and cleaning supplies and first aid cabinet services and other safety supplies, to a variety of manufacturers, retailers and service companies.
Cost of revenues include the amortization of rental merchandise in service and merchandise costs related to direct sales as well as labor and other production, service and delivery costs, and distribution costs associated with operating our Core Laundry Operations, Specialty Garments facilities, and First Aid locations. Selling and administrative costs include costs related to our sales and marketing functions as well as general and administrative costs associated with our corporate offices, non-operating environmental sites and operating locations including information systems, engineering, materials management, manufacturing planning, finance, budgeting, and human resources.
We have a substantial number of plants and conduct a significant portion of our business in energy producing regions in the U.S. and Canada. In general, we are relatively more dependent on business in these regions than are many of our competitors. Recent volatility in energy prices have had and may continue to have a significant impact on wearer levels at existing customers in our North American energy-dependent markets. Our operating results are also directly impacted by the costs of the gasoline used to fuel our vehicles and the natural gas used to operate our plants. While it is difficult to quantify the positive and negative impacts on our future financial results from changes in energy prices, in general, we believe that significant decreases in oil and natural gas prices would have an overall negative impact on our results due to cutbacks by our customers both in, and dependent upon, the oil and natural gas industries, which would outweigh the benefits in our operating costs from lower energy costs.
Our business is subject to various state and federal regulations, including employment laws and regulations, minimum wage requirements, overtime requirements, working condition requirements, citizenship requirements, healthcare insurance mandates and other laws and regulations that impact our labor costs. Labor costs increased in fiscal 2020 as a result of increases in state and local minimum wage levels as well as the overall impact of wage pressure as the result of a low unemployment environment.
On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJA”) was enacted into law, which, among other provisions, reduced the U.S. federal corporate income tax rate effective January 1, 2018 from a top marginal rate of 35% to a new 21% corporate rate and imposed a one-time transition tax on the deemed repatriation of certain deferred foreign income. We have made reasonable estimates of the effects of the TCJA and these estimates could change in future periods as we continue to analyze the effects of the TCJA (see Note 4, “Income Taxes” to our Consolidated Financial Statements included in this Annual Report on Form 10-K). As a result of the TCJA, U.S. corporations are subject to lower income tax rates, and we were required to remeasure our U.S. net deferred tax liabilities at a lower rate, resulting in a net benefit of $22.6 million recorded in the provision for income taxes as of August 25, 2018. Partially offsetting this benefit, we recorded a charge of $2.5 million for transition taxes related to the deemed repatriation of foreign earnings as of August 29, 2019.
A portion of our sales is derived from international markets, including Canada. Revenues denominated in currencies other than the U.S. dollar represented approximately 6.9%, 7.0% and 8.1% of total consolidated revenues for fiscal years 2020, 2019 and 2018, respectively. The operating results of our international subsidiaries are translated into U.S. dollars and such results are affected by movements in foreign currencies relative to the U.S. dollar. In addition, a weaker Canadian dollar increases the costs to our Canadian operations of merchandise and other operational inputs that are sourced from outside Canada, which has the effect of reducing the operating margins of our Canadian business if we are unable to recover these additional costs through price adjustments with our Canadian customers. In fiscal 2020 and 2019, foreign currency fluctuations impacted our consolidated revenues negatively by 0.1% and 0.3%, respectively. In fiscal 2018, foreign currency fluctuations negligibly impacted our consolidated revenues. These impacts were primarily driven by fluctuations in the Canadian dollar. Our operating results in future years could be negatively impacted by any further devaluation, as compared to the U.S. dollar, of the Canadian dollar or any of the currencies of the other countries in which we operate.
On March 27, 2018, we repurchased 1.105 million shares of Class B Common Stock and 0.073 million shares of Common Stock for a combined $146.0 million in a private transaction with the Croatti family at a per share price of $124.00. This opportunity to repurchase shares from the Croatti family was evaluated by an independent special committee of the Board of Directors (the “Special Committee”). The sale of shares by the Croatti family was executed to provide liquidity as well as for estate and family financial planning following the passing of our former Chief Executive Officer, Ronald D. Croatti. The Special Committee determined that a repurchase of Croatti family Class B Common Stock at a discount to market was in our
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best interests as it is accretive to income per share and addresses uncertainties that may have been created if the Croatti family had pursued other liquidity options.
The Special Committee undertook its evaluation with the assistance of Stifel Financial Corp. (“Stifel”) and received an opinion from Stifel to the effect that, as of March 27, 2018, the $124.00 per share in cash to be paid was fair to us, from a financial point of view. The entire Board of Directors other than Cynthia Croatti, who is affiliated with the selling shareholders and therefore abstained, approved the transaction upon the recommendation of the Special Committee.
On March 28, 2018, we announced that we would be raising our quarterly dividend to $0.1125 per share for Common Stock and to $0.09 per share for Class B Common Stock, up from $0.0375 and $0.03 per share, respectively.
On October 23, 2019, we announced that we would be raising our quarterly dividend to $0.25 per share for Common Stock and to $0.20 per share for Class B Common Stock, up from $0.1125 and $0.09 per share, respectively. The amount and timing of any future dividend payment is subject to the approval of the Board of Directors each quarter.
On January 2, 2019, our Board of Directors approved a share repurchase program authorizing the Company to repurchase from time to time up to $100.0 million of its outstanding shares of Common Stock. Repurchases made under the program, if any, will be made in either the open market or in privately negotiated transactions. The timing, manner, price and amount of any repurchases will depend on a variety of factors, including economic and market conditions, the Company stock price, corporate liquidity requirements and priorities, applicable legal requirements and other factors. The share repurchase program will be funded using the Company’s available cash or capacity under its Credit Agreement (as defined below) and may be suspended or discontinued at any time. During fiscal 2020, the Company repurchased 0.1 million shares for an average price per share of $184.67. During fiscal 2019, the Company repurchased 0.2 million shares for an average price per share of $154.78.
During fiscal 2017, we recorded a pre-tax non-cash impairment charge of $55.8 million once it was determined that it was not probable that the version of the CRM system that was being developed would be completed and placed into service. On December 28, 2018, we entered into a settlement agreement with our lead contractor for the version of the CRM system with respect to which we recorded the impairment charge. As part of the settlement agreement, we recorded in the second quarter ended February 23, 2019 a total gain of $21.1 million as a reduction of selling and administrative expenses, which includes our receipt of a one-time cash payment in the amount of $13.0 million as well as the forgiveness of amounts previously due the contractor. We also received hardware and related maintenance service with a fair value of $0.8 million as part of the settlement.
In fiscal 2018, we initiated a multiyear CRM project to further develop, implement and deploy a third-party application we licensed. This new solution is intended to improve functionality, capability and information flow as well as increase automation in servicing our customers. As of August 29, 2020, we have capitalized $22.6 million related to our new CRM project.
Our fiscal year ends on the last Saturday in August. For financial reporting purposes fiscal 2020 and fiscal 2018 both consisted of 52 weeks and fiscal 2019 consisted of 53 weeks.
Fiscal Year Ended August 29, 2020 Compared with Fiscal Year Ended August 31, 2019
Revenues
Fiscal
2020
Fiscal
2019
Dollar
Change
Percent
Change
(In thousands, except percentages)
Core Laundry Operations
$
1,601,485
$
1,616,205
$
(14,720
)
(0.9
)%
Specialty Garments
133,185
132,767
418
0.3
%
First Aid
69,489
60,404
9,085
15.0
%
Total consolidated revenues
$
1,804,159
$
1,809,376
$
(5,217
)
(0.3
)%
The decrease in our consolidated revenues in fiscal 2020 compared to the prior fiscal year was due primarily to a decline in our Core Laundry Operations. Of this decline, 1.9% was due to the extra week in fiscal 2019. Also contributing to the decline was the negative impact on rental revenues from COVID-19 related customer closures as well as related wearer
27
reductions at customers that remained open. These declines were partially offset in fiscal 2020 by a large direct sale of $20.1 million .
The Specialty Garments segment’s results are often affected by seasonality and the timing and length of its customers’ power reactor outages as well as its project-based activities. The improvement in revenues in fiscal 2020 compared to fiscal 2019 was due primarily to increased direct sales activity in our nuclear operations in the U.S. and Canada as well as strong performance in our cleanroom operations. These increases were partially offset by a decline in revenue from the extra week in fiscal 2019.
The increase in our First Aid revenues in fiscal 2020 compared to fiscal 2019 was due primarily to the strong performance in our wholesale distribution business and increased demand for the segment’s safety and personal protective equipment offerings as a result of COVID-19. These increases were partially offset by a decline in revenue from the extra week in fiscal 2019.
Cost of revenues
(In thousands, except percentages)
Fiscal 2020
Fiscal 2019
Dollar
Change
Percent
Change
Cost of revenues
$
1,164,932
$
1,139,195
$
25,737
2.3
%
% of Revenues
64.6
%
63.0
%
Core Laundry Operations cost of revenues as a percentage of revenues in fiscal 2020 increased from the prior fiscal year. This increase was due to a number of items, including the impact of the decline in our rental revenues on our cost structure, higher merchandise amortization as a percentage of revenues due to the amortization of prior period expenditures, higher cost of revenues related to the large $20.1 million direct sale, additional employee compensation expense, higher bad debt expense, higher casualty claims expense, as well as increased costs for internal-use safety supplies. These items were partially offset by lower incentive compensation, energy, travel-related and healthcare claim costs in fiscal 2020.
Our Specialty Garments cost of revenues as a percentage of revenues decreased in fiscal 2020 as compared to the prior fiscal year. The decrease was due primarily to lower production and service, delivery payroll and other delivery costs in fiscal 2020.
Selling and administrative expenses
(In thousands, except percentages)
Fiscal 2020
Fiscal 2019
Dollar
Change
Percent
Change
Selling and administrative expenses
$
361,801
$
334,840
$
26,961
8.1
%
% of Revenues
20.1
%
18.5
%
The increase in our selling and administrative expenses as a percentage of revenues in fiscal 2020 compared to fiscal 2019 was due primarily to a gain of $21.1 million in fiscal 2019 related to the settlement agreement with the lead contractor for the version of the CRM system with respect to which we recorded a $55.8 million impairment charge in fiscal 2017. Also contributing to the increase was a gain of $3.0 million from the settlement of environmental litigation in fiscal 2019 and higher indirect tax costs in fiscal 2020. The items driving the increase in fiscal 2020 were partially offset by lower healthcare claim, travel-related, incentive and other compensation-related costs.
Depreciation and amortization
(In thousands, except percentages)
Fiscal 2020
Fiscal 2019
Dollar
Change
Percent
Change
Depreciation and amortization
$
104,697
$
103,333
$
1,364
1.3
%
% of Revenues
5.8
%
5.7
%
Depreciation and amortization expense increased in fiscal 2020 as compared to the prior fiscal year due primarily to capital expenditures placed in service over the past several quarters. The increase in depreciation and amortization reflects our continued capital investments in the business.
28
Income from operations
For fiscal 2020, the changes in revenues in our Core Laundry Operations, Specialty Garments and First Aid segments, as well as the changes in our costs discussed above, resulted in the following changes in our income from operations:
Fiscal
2020
Fiscal
2019
Dollar
Change
Percent
Change
(In thousands, except percentages)
Core Laundry Operations
$
149,987
$
212,954
$
(62,967
)
(29.6
)%
Specialty Garments
17,845
14,145
3,700
26.2
%
First Aid
4,897
4,909
(12
)
(0.2
)%
Total consolidated income from operations
$
172,729
$
232,008
$
(59,279
)
(25.6
)%
Percentage of total revenues
9.6
%
12.8
%
Other income, net
(In thousands, except percentages)
Fiscal 2020
Fiscal 2019
Dollar
Change
Percent
Change
Interest income, net
$
(6,382
)
$
(9,082
)
$
2,700
(29.7
)%
Other expense, net
1,223
3,166
(1,943
)
(61.4
)%
Total other income, net
$
(5,159
)
$
(5,916
)
$
757
(12.8
)%
The decrease in other income, net, during fiscal 2020 as compared to the prior fiscal year was due primarily to lower interest income from declining interest rates partially offset by higher foreign currency exchange gains.
Provision for income taxes
(In thousands, except percentages)
Fiscal 2020
Fiscal 2019
Dollar
Change
Percent
Change
Provision for income taxes
$
42,118
$
58,790
$
(16,672
)
(28.4
)%
Effective income tax rate
23.7
%
24.7
%
The decrease in our effective income tax rate for fiscal 2020 as compared to fiscal 2019 was due primarily to a $1.8 million benefit as a result of the relief of certain tax reserves and a $1.6 million discrete tax benefit related to the exercise of stock appreciation rights.
Fiscal Year Ended August 31, 2019 Compared with Fiscal Year Ended August 26, 2018
Revenues
Fiscal
2019
Fiscal
2018
Dollar
Change
Percent
Change
(In thousands, except percentages)
Core Laundry Operations
$
1,616,205
$
1,523,648
$
92,557
6.1
%
Specialty Garments
132,767
118,477
14,290
12.1
%
First Aid
60,404
54,364
6,040
11.1
%
Total consolidated revenues
$
1,809,376
$
1,696,489
$
112,887
6.7
%
The increase of our consolidated revenues in fiscal 2019 compared to the prior fiscal year was due primarily to growth in our Core Laundry Operations. The growth in our Core Laundry Operations was comprised of 3.8% of organic growth, 2.0% growth from the extra week in fiscal 2019 and 0.3% growth from acquisitions. Organic growth consists primarily of new sales, price increases, and net changes in the wearer levels at our existing customers, offset by lost accounts. Core Laundry Operations’ organic growth in fiscal 2019 benefitted from strong new accounts sales as well as reduced lost accounts.
The Specialty Garments segment’s results are often affected by seasonality and the timing and length of its customers’ power reactor outages as well as its project-based activities. The improvement in revenues in fiscal 2019 compared to fiscal 2018 was primarily comprised of 7.4% growth from acquisitions, 2.7% of organic growth from increased outages and project-
29
based activity at the segment’s Canadian and European nuclear cu stomers, and 2.0% growth from the extra week in fiscal 2019.
The increase of our First Aid revenues in fiscal 2019 compared to fiscal 2018 was comprised of 7.8% of organic growth, 1.9% growth from the extra week in fiscal 2019 and 1.5% growth from acquisitions.
Cost of revenues
(In thousands, except percentages)
Fiscal 2019
Fiscal 2018
Dollar
Change
Percent
Change
Cost of revenues
1,139,195
1,056,724
82,471
7.8
%
% of Revenues
63.0
%
62.3
%
Cost of revenues as a percentage of revenues was 63.0% for fiscal 2019 as compared to 62.3% in fiscal 2018.
Our Core Laundry Operations cost of revenues as a percentage of revenues increased to 62.5% for fiscal 2019 from 61.8% for fiscal 2018. This increase was due primarily to higher merchandise and service and delivery payroll costs, which were partially offset by lower healthcare claims.
Our Specialty Garments cost of revenues as a percentage of revenues was 67.1% for fiscal 2019 as compared to 65.3% for fiscal 2018. The increase was due primarily to higher merchandise costs related to acquisitions in the second half of fiscal 2018 as well as higher expenses related to workers’ compensation and auto claims. These increases were partially offset by lower healthcare claims.
Our First Aid costs of revenues as a percentage of revenues was 67.4% for fiscal 2019 as compared to 68.1% for fiscal 2018. The decrease was due primarily to lower merchandise and production costs in our wholesale distribution business in fiscal 2019.
Selling and administrative expense
(In thousands, except percentages)
Fiscal 2019
Fiscal 2018
Dollar
Change
Percent
Change
Selling and administrative expenses
$
334,840
$
360,727
$
(25,887
)
(7.2
)%
% of Revenues
18.5
%
21.3
%
The decrease in our selling and administrative expenses as a percentage of revenues in fiscal 2019 compared to fiscal 2018 was due primarily to a gain of $21.1 million in fiscal 2019 related to the settlement agreement with the lead contractor for the version of the CRM system with respect to which we recorded a $55.8 million impairment charge in fiscal 2017. Also contributing to the decrease was a $7.2 million one-time cash bonus in fiscal 2018 to our employees so that they could share in the benefits received by the Company from U.S. tax reform, a gain of $3.0 million from the settlement of environmental litigation in the first quarter of fiscal 2019, lower healthcare claims, the capitalization of internal labor costs beginning in the fourth quarter of fiscal 2018 related to the development of the new CRM project we initiated in fiscal 2018, and the capitalization of sales commission costs upon the adoption of new revenue accounting guidance in fiscal 2019.
Depreciation and amortization
(In thousands, except percentages)
Fiscal 2019
Fiscal 2018
Dollar
Change
Percent
Change
Depreciation and amortization
$
103,333
$
96,662
$
6,671
6.9
%
% of Revenues
5.7
%
5.7
%
The increase in depreciation and amortization reflects the Company’s continued capital investments in the business. However, in fiscal 2019, depreciation and amortization remained consistent with fiscal 2018 as a percentage of revenue.
30
Income from operations
For fiscal 2019, the changes in revenues in our Core Laundry Operations, Specialty Garments and First Aid segments, as well as the changes in our costs discussed above, resulted in the following changes in our income from operations:
Fiscal
2019
Fiscal
2018
Dollar
Change
Percent
Change
(In thousands, except percentages)
Core Laundry Operations
$
212,954
$
163,588
$
49,366
30.2
%
Specialty Garments
14,145
14,070
75
0.5
%
First Aid
4,909
4,718
191
4.0
%
Total consolidated income from operations
$
232,008
$
182,376
$
49,632
27.2
%
Percentage of total revenues
12.8
%
10.8
%
Other income, net
(In thousands, except percentages)
Fiscal 2019
Fiscal 2018
Dollar
Change
Percent
Change
Interest income, net
$
(9,082
)
$
(5,543
)
$
(3,539
)
63.8
%
Other expense, net
3,166
673
2,493
370.4
%
Total other income, net
$
(5,916
)
$
(4,870
)
$
(1,046
)
21.5
%
Other income, net, which includes interest income and other expense, increased by $1.0 million or 21.5% in fiscal 2019 as compared to fiscal 2018. This change was due primarily to higher interest income from higher interest rates as well as greater amounts of cash invested. This increase was partially offset by an increase in other expense from the adoption of new accounting guidance that resulted in the presentation of periodic pension costs amounting to $2.1 million in other income, net in fiscal 2019 that was presented in selling and administrative expenses in the prior fiscal year.
Provision for income taxes
(In thousands, except percentages)
Fiscal 2019
Fiscal 2018
Dollar
Change
Percent
Change
Provision for income taxes
$
58,790
$
23,351
$
35,439
151.8
%
Effective income tax rate
24.7
%
12.5
%
The increase in our effective income tax rate for fiscal 2019 as compared to fiscal 2018 was due primarily to the impact of the TCJA, which lowered the U.S. federal corporate income tax rates as of January 1, 2018 to 21.0% from 35.0%. These new rates required us to remeasure our U.S. net deferred income tax liabilities in fiscal 2018. Also, we were subject to a one-time transition tax for the deemed repatriation of our deferred foreign income. The remeasurement of our U.S. net deferred tax liabilities and the one-time transition tax resulted in a $20.1 million net benefit to our provision for income taxes in the second quarter of fiscal 2018. For additional information pertaining to income taxes and the TCJA, please refer to Note 4, “Income Taxes” to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
Liquidity and Capital Resources
General
Cash, cash equivalents and short-term investments totaled $474.8 million as of August 29, 2020, an increase of $89.5 million from $385.3 million as of August 31, 2019. We generated $286.7 million and $282.1 million in cash from operating activities in the fiscal years ended August 29, 2020 and August 31, 2019, respectively.
Pursuant to a share repurchase program approved by the Board of Directors on January 2, 2019, we repurchased 0.1 million shares of our Common Stock for an aggregate of approximately $21.7 million during fiscal 2020 and 0.2 million shares of our Common Stock for an aggregate $30.5 million during fiscal 2019. On March 27, 2018, we repurchased 1.105 million shares of Class B Common Stock and 0.073 million shares of Common Stock for a combined $146.0 million in a private transaction with the Croatti family at a per share price of $124.00.
31
We believe , although there can be no assurance, t hat our current cash, cash equivalents and short-term investments balances, our cash generated from future operations and amounts available under our Credit Agreement (defined below) will be sufficient to meet our current anticipated working capital and capital expenditure requirements for at least the next 12 months and will help us manage the impacts of the COVID-19 pandemic on our business and address related liquidity needs .
Cash flows provided by operating activities have historically been the primary source of our liquidity. We generally use these cash flows to fund most, if not all, of our operations, capital expenditure and acquisition activities as well as dividends on our Common Stock. We may also use cash flows provided by operating activities, as well as proceeds from loans payable and long-term debt, to fund growth and acquisition opportunities, as well as other cash requirements.
(In thousands, except percentages)
Fiscal
2020
Fiscal
2019
Percent
Change
Net cash provided by operating activities
$
286,684
$
282,142
1.6
%
Net cash used in investing activities
(157,616
)
(124,329
)
26.8
%
Net cash used in financing activities
(41,103
)
(41,491
)
(0.9
)%
Effect of exchange rate changes
1,532
(1,493
)
(202.6
)%
Net increase in cash, cash equivalents and
short-term investments
$
89,497
$
114,829
(22.1
)%
Net Cash Provided by Operating Activities
The increase in net cash provided by operating activities was due primarily to lower expenditures on rental merchandise and declining accounts receivable in fiscal 2020 as compared to the prior fiscal year due to lower revenues. Also contributing to the increase was the one-time bonus paid to our employees during the first quarter of fiscal 2019. These increases were partially offset by cash received of $13.0 million in the second quarter of fiscal 2019 from the settlement agreement with the lead contractor for the version of the CRM system with respect to which we recorded a $55.8 million impairment charge in fiscal 2017. Also partially offsetting the increases was $3.0 million from the settlement of environmental litigation in the first quarter of fiscal 2019.
Net Cash Used in Investing Activities
The net increase in cash used in investing activities was due primarily to the acquisition of a Missouri-based industrial laundry business, which was completed in September 2019 for $38.8 million, using available cash on hand. This increase was partially offset by lower capital expenditures of $3.1 million in fiscal 2020 as compared to the prior year comparable period.
Net Cash Used in Financing Activities
The decrease in cash used in financing activities was due primarily to lower repurchases of Common Stock partially offset by an increase in dividends paid of $7.4 million in fiscal 2020 as compared to the prior fiscal year.
Long-term debt and borrowing capacity
We have a $250.0 million unsecured revolving credit agreement (the “Credit Agreement”) with a syndicate of banks, which matures on April 11, 2021. Under the Credit Agreement, we are able to borrow funds at variable interest rates based on, at our election, the Eurodollar rate or a base rate, plus in each case a spread based on our consolidated funded debt ratio. Availability of credit requires compliance with certain financial and other covenants, including a maximum consolidated funded debt ratio and minimum consolidated interest coverage ratio as defined in the Credit Agreement. We test our compliance with these financial covenants on a fiscal quarterly basis. As of August 29, 2020, the interest rates applicable to our borrowings under the Credit Agreement would be calculated as LIBOR plus 75 basis points at the time of the respective borrowing. As of August 29, 2020, we had no outstanding borrowings and had outstanding letters of credit amounting to $70.8 million, leaving $179.2 million available for borrowing under the Credit Agreement. We expect to replace the Credit Agreement prior to its maturity with a new revolving credit facility.
As of August 29, 2020, we were in compliance with all covenants under the Credit Agreement.
Derivative Instruments and Hedging Activities
In June 2018, we entered into twelve forward contracts to exchange CAD for U.S. dollars at fixed exchange rates in order to manage our exposure related to certain forecasted CAD denominated sales of one of our subsidiaries. The hedged transactions are specified as the first amount of CAD denominated revenues invoiced by one of our domestic subsidiaries
32
each fiscal quarter, beginning in the third fiscal quarter of 2019 and continuing through the second fiscal quarter of 2022. In total, we will sell approximately 12.1 million CAD at an average Canadian-dollar exchange rate of 0.7814 over these quarterly periods. We concluded that the forward contracts met the criteria to qualify as a cash flow hedge under U.S. GAAP.
As of August 29, 2020, we had forward contracts with a notional value of approximately 5.0 million CAD outstanding and recorded the fair value of the contracts of 0.1 million CAD in prepaid expenses and other current assets with a corresponding $0.1 million gain in accumulated other comprehensive loss, which was recorded net of tax. During fiscal 2020, we reclassified $0.2 million from accumulated other comprehensive loss to revenue, related to the derivative financial instruments. The gain on these forward contracts that results in a decrease to accumulated other comprehensive loss as of August 29, 2020 is expected to be reclassified to revenues prior to its maturity on February 25, 2022.
Environmental and Legal Contingencies
We are subject to various federal, state and local laws and regulations governing, among other things, air emissions, wastewater discharges, and the generation, handling, storage, transportation, treatment and disposal of hazardous wastes and other substances. In particular, industrial laundries currently use and must dispose of detergent waste water and other residues, and, in the past, used perchloroethylene and other dry cleaning solvents. We are attentive to the environmental concerns surrounding the disposal of these materials and have, through the years, taken measures to avoid their improper disposal. We have settled, or contributed to the settlement of, past actions or claims brought against us relating to the disposal of hazardous materials at several sites and there can be no assurance that we will not have to expend material amounts to remediate the consequences of any such disposal in the future.
U.S. GAAP requires that a liability for contingencies be recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence of a liability, as well as the amount to be recorded. We regularly consult with attorneys and outside consultants in our consideration of the relevant facts and circumstances before recording a contingent liability. Changes in enacted laws, regulatory orders or decrees, our estimates of costs, risk-free interest rates, insurance proceeds, participation by other parties, the timing of payments, the input of our attorneys and outside consultants or other factual circumstances could have a material impact on the amounts recorded for our environmental and other contingent liabilities.
Under environmental laws, an owner or lessee of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances located on, or in, or emanating from such property, as well as related costs of investigation and property damage. Such laws often impose liability without regard to whether the owner or lessee knew of, or was responsible for, the presence of such hazardous or toxic substances. There can be no assurances that acquired or leased locations have been operated in compliance with environmental laws and regulations or that future uses or conditions will not result in the imposition of liability upon our Company under such laws or expose our Company to third party actions such as tort suits. We continue to address environmental conditions under terms of consent orders negotiated with the applicable environmental authorities or otherwise with respect to certain sites.
We have accrued certain costs related to certain sites, including but not limited to sites in Woburn and Somerville, Massachusetts, as it has been determined that the costs are probable and can be reasonably estimated. We have potential exposure related to a parcel of land (the “Central Area”) related to a site in Woburn, Massachusetts site. Currently, the consent decree for the Woburn site does not define or require any remediation work in the Central Area. The United States Environmental Protection Agency (the “EPA”) has provided us and other signatories to the consent decree with comments on the design and implementation of groundwater and soil remedies at the Woburn site and investigation of environmental conditions in the Central Area. We, and other signatories, have implemented and proposed to do additional work at the Woburn site but many of the EPA’s comments remain to be resolved. We have accrued costs to perform certain work responsive to the EPA’s comments. Additionally, we have implemented mitigation measures and continue to monitor environmental conditions at a site in Somerville, Massachusetts. We have received, responded, and agreed to undertake additional response actions pertaining to a notice of audit findings from the Massachusetts Department of Environmental Protection concerning a regulatory submittal that we made in 2009 for a portion of the site. We have received demands from the local transit authority for reimbursement of certain costs associated with its construction of a new municipal transit station in the area of the Somerville site. This station is part of an ongoing extension of the transit system. We have reserved for costs in connection with this matter; however, in light of the uncertainties associated with this matter, these costs and the related reserve may change.
We routinely review and evaluate sites that may require remediation and monitoring and determine our estimated costs based on various estimates and assumptions. These estimates are developed using our internal sources or by third-party environmental engineers or other service providers. Internally developed estimates are based on:
•
Management’s judgment and experience in remediating and monitoring our sites;
33
•
Information available from regulatory agencies as to costs of remediation and monitoring;
•
The number, financial resources and relative degree of responsibility of other potentially responsible parties (PRPs) who may be liable for remediation and monitoring of a specific site; and
•
The typical allocation of costs among PRPs.
There is usually a range of reasonable estimates of the costs associated with each site. In accordance with U.S. GAAP, our accruals represent the amount within the range that we believe is the best estimate or the low end of a range of estimates if no point within the range is a better estimate. When we believe that both the amount of a particular liability and the timing of the payments are reliably determinable, we adjust the cost in current dollars using a rate of 3% for inflation until the time of expected payment and discount the cost to present value using current risk-free interest rates. As of August 29, 2020, the risk-free interest rates we utilized ranged from 0.7% to 1.5%.
For environmental liabilities that have been discounted, we include interest accretion, based on the effective interest method, in selling and administrative expenses on the Consolidated Statements of Income. The changes to the amounts of our environmental liabilities for the years ended August 29, 2020 and August 31, 2019 are as follows (in thousands):
Year ended
August 29,
2020
August 31,
2019
Beginning balance
$
27,718
$
25,486
Costs incurred for which reserves have been provided
(1,160
)
(1,079
)
Insurance proceeds
111
143
Interest accretion
537
755
Changes in discount rates
1,133
2,239
Revisions in estimates
2,363
174
Ending balance
$
30,702
$
27,718
Anticipated payments and insurance proceeds of currently identified environmental remediation liabilities as of August 29, 2020 for the next five fiscal years and thereafter, as measured in current dollars, are reflected below (in thousands).
Fiscal year ended August
2021
2022
2023
2024
2025
Thereafter
Total
Estimated costs—current dollars
$
11,368
$
2,668
$
1,371
$
1,073
$
1,076
$
11,852
$
29,408
Estimated insurance proceeds
(197
)
(159
)
(173
)
(159
)
(173
)
(521
)
(1,382
)
Net anticipated costs
$
11,171
$
2,509
$
1,198
$
914
$
903
$
11,331
$
28,026
Effect of inflation
7,251
Effect of discounting
(4,575
)
Balance as of August 29, 2020
$
30,702
Estimated insurance proceeds are primarily received from an annuity received as part of our legal settlement with an insurance company. Annual proceeds of approximately $0.3 million are deposited into an escrow account which funds remediation and monitoring costs for two sites related to our former operations. Annual proceeds received but not expended in the current year accumulate in this account and may be used in future years for costs related to this site through the year 2027. As of August 29, 2020, the balance in this escrow account, which is held in a trust and is not recorded in our Consolidated Balance Sheet, was approximately $4.5 million. Also included in estimated insurance proceeds are amounts we are entitled to receive pursuant to legal settlements as reimbursements from three insurance companies for estimated costs at one of our sites.
Our nuclear garment decontamination facilities are licensed by the Nuclear Regulatory Commission, or, in certain cases, by the applicable state agency, and are subject to regulation by federal, state and local authorities. We also have nuclear garment decontamination facilities in the United Kingdom and the Netherlands. These facilities are licensed and regulated by the respective country’s applicable federal agency. There can be no assurance that such regulation will not lead to material disruptions in our garment decontamination business.
From time to time, we are also subject to legal proceedings and claims arising from the conduct of our business operations, including personal injury claims, customer contract matters, employment claims and environmental matters as described above.
While it is impossible for us to ascertain the ultimate legal and financial liability with respect to contingent liabilities, including lawsuits and environmental contingencies, we believe that the aggregate amount of such liabilities, if any, in excess of amounts covered by insurance have been properly accrued in accordance with accounting principles generally accepted in
34
the United States. It is possible, however, that the future financial position and/or results of operations for any particular future period could be materially affected by changes in our assumptions or strategies related to these contingencies or changes out of our control.
Acquisitions
As part of our business, we regularly evaluate opportunities to acquire other garment service companies. In recent years, we have typically paid for acquisitions with cash and may continue to do so in the future. To pay for an acquisition, we may use cash on hand, cash generated from operations or borrowings under our Credit Agreement, or we may pursue other forms of debt financing. Our ability to secure short-term and long-term debt financing in the future will depend on several factors, including our future profitability, our levels of debt and equity, and the overall credit and equity market environments.
Contractual Obligations and Other Commercial Commitments
The following information is presented as of August 29, 2020 (in thousands).
Payments Due by Fiscal Period
Contractual Obligations
Total
Less than
1 year
1 – 3 years
3 – 5 years
More than
5 years
Retirement plan benefit payments
$
44,084
$
1,917
$
3,254
$
3,871
$
35,042
Asset retirement obligations
13,920
—
3,514
—
10,406
Operating leases
44,228
13,458
18,273
8,602
3,895
Forward contracts
4,950
3,510
1,440
—
—
Purchase Commitments*
22,400
19,000
3,200
200
—
Total contractual cash obligations
$
129,582
$
37,885
$
29,681
$
12,673
$
49,343
*Includes non-cancellable purchase commitments for inventories, software, and services.
We have uncertain tax positions that are reserved totaling $6.3 million as of August 29, 2020 that are excluded from the above table as we cannot make a reasonably reliable estimate of the period of cash settlement with the respective taxing authority.
We have accrued $30.7 million in costs related to certain environmental obligations we have to address under terms of consent orders negotiated with the applicable environmental authorities or otherwise. Refer to “Environmental and Legal Contingencies”, above for additional discussion on our environmental obligations.
As discussed above under “Long-Term Debt and Borrowing Capacity”, as of August 29, 2020, we had borrowing capacity of $250.0 million under our Credit Agreement, of which approximately $179.2 million was available for borrowing. Also, as of such date, we had no outstanding borrowings and letters of credit outstanding of $70.8 million. All letters of credit expire in less than one year. We expect to replace the Credit Agreement prior to its maturity with a new revolving line of credit on appropriate terms.
As discussed above under “Derivative Instruments and Hedging Activities”, as of August 29, 2020, we had forward contracts with a notional value of approximately 5.0 million CAD outstanding and recorded the fair value of the contracts of $0.1 million in prepaid expenses and other current assets with a corresponding $0.1 million gain in accumulated other comprehensive loss, which was recorded net of tax. During fiscal 2020, we reclassified $0.2 million from accumulated other comprehensive loss to revenue, related to the derivative financial instruments. The gain on these forward contracts that results in decrease to accumulated other comprehensive loss as of August 29, 2020 is expected to be reclassified to revenues prior to its maturity on February 25, 2022.
Off Balance Sheet Arrangements
As of August 29, 2020, we did not have any off balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Securities and Exchange Commission Regulation S-K.
Effects of Inflation
In general, we believe that our results of operations are not dependent on moderate changes in the inflation rate. Historically, we have been able to manage the impacts of more significant changes in inflation rates through our customer relationships,
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customer agreements that generally provide for price increases consistent with the rate of inflation, and continued focus on improvements of operational productivity.
Energy Costs
Significant increases in energy costs, specifically with respect to natural gas and gasoline, can materially affect our operating costs. During fiscal 2020, our energy costs, which include fuel, natural gas, and electricity, represented approximately 3.6% of our total revenue.
Recent Accounting Pronouncements
See Note 1, “Summary of Significant Accounting Policies” to our Consolidated Financial Statements included in this Annual Report on Form 10-K for more information on recently implemented and issued accounting standards
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