UNIFIRST CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS SAFE HARBOR FOR FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q and any documents incorporated by reference may contain forward-looking statements within the meaning of the federal securities laws. Forward-looking statements contained in this Quarterly Report on Form 10-Q and any documents incorporated by reference are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by words such as “estimates,” “anticipates,” “projects,” “plans,” “expects,” “intends,” “believes,” “seeks,” “could,” “should,” “may,” “will,” “strategy,” “objective,” “assume,” “strive,” or the negative versions thereof, and similar expressions and by the context in which they are used. Such forward-looking statements are based upon our current expectations and speak only as of the date made. Such statements are highly dependent upon a variety of risks, uncertainties and other important factors that could cause actual results to differ materially from those reflected in such forward-looking statements. Such factors include, but are not limited to, uncertainties caused by adverse economic conditions, including, without limitation, as a result of extraordinary events or circumstances such as the COVID-19 pandemic, and their impact on our customers’ businesses and workforce levels, disruptions of our business and operations, including limitations on, or closures of, our facilities, or the business and operations of our customers or suppliers in connection with extraordinary events or circumstances such as the COVID-19 pandemic, uncertainties regarding our ability to consummate and successfully integrate acquired businesses, uncertainties regarding any existing or newly-discovered expenses and liabilities related to environmental compliance and remediation, any adverse outcome of pending or future contingencies or claims, our ability to compete successfully without any significant degradation in our margin rates, seasonal and quarterly fluctuations in business levels, our ability to preserve positive labor relationships and avoid becoming the target of corporate labor unionization campaigns that could disrupt our business, the effect of currency fluctuations on our results of operations and financial condition, our dependence on third parties to supply us with raw materials, which such supply could be severely disrupted as a result of extraordinary events or circumstances such as the COVID-19 pandemic, any loss of key management or other personnel, increased costs as a result of any changes in federal or state laws, rules and regulations or governmental interpretation of such laws, rules and regulations, uncertainties regarding the price levels of natural gas, electricity, fuel and labor, the negative effect on our business from sharply depressed oil and natural gas prices, including, without limitation, as a result of extraordinary events or circumstances such as the COVID-19 pandemic, the continuing increase in domestic healthcare costs, increased workers’ compensation claim costs, increased healthcare claim costs, including as a result of extraordinary events or circumstances such as the COVID-19 pandemic, our ability to retain and grow our customer base, demand and prices for our products and services, fluctuations in our Specialty Garments business, political or other instability, supply chain disruption or infection among our employees in Mexico and Nicaragua where our principal garment manufacturing plants are located, including, without limitation, as a result of extraordinary events or circumstances such as the COVID-19 pandemic, our ability to properly and efficiently design, construct, implement and operate a new customer relationship management (“CRM”) computer system, interruptions or failures of our information technology systems, including as a result of cyber-attacks, additional professional and internal costs necessary for compliance with any changes in Securities and Exchange Commission, New York Stock Exchange and accounting rules, strikes and unemployment levels, our efforts to evaluate and potentially reduce internal costs, economic and other developments associated with the war on terrorism and its impact on the economy, the impact of foreign trade policies and tariffs or other impositions on imported goods on our business, results of operations and financial condition, general economic conditions, our ability to successfully implement our business strategies and processes, including our capital allocation strategies and the other factors described under “Item 1A. Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended August 29, 2020 and in our other filings with the Securities and Exchange Commission, including, without limitation, under “Item 1A. Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. We undertake no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made. 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 and hand soaps. 23 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. We continue to expand into additional geographic markets through acquisitions and organic growth. We currently service over 300,000 customer locations in the United States, Canada and Europe from over 260 customer service, distribution and manufacturing facilities. As mentioned and described in Note 16 to our Consolidated Financial Statements, we have five reporting segments: U.S. and Canadian Rental and Cleaning, MFG, Corporate, Specialty Garments and First Aid. We refer to the laundry locations of the U.S. and Canadian Rental and Cleaning reporting segment as “industrial laundries” or “industrial laundry locations”, and to the U.S. and Canadian Rental and Cleaning, MFG, and Corporate reporting segments combined as our “Core Laundry Operations.” Critical Accounting Policies and Estimates The discussion of our financial condition and results of operations is based upon the Consolidated Financial Statements, which have been prepared in conformity with United States generally accepted accounting principles (“U.S. GAAP”). As such, management is required to make certain estimates, judgments and assumptions that are believed to be reasonable based on the information available. These estimates and assumptions affect the reported amount of assets and liabilities, revenues and expenses, and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, the most important and pervasive accounting policies used and areas most sensitive to material changes from external factors. The critical accounting estimates that we believe affect our more significant judgments and estimates used in the preparation of our consolidated financial statements presented in this report are described in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended August 29, 2020. 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 and the first half of fiscal 2021 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. . 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, including the emergence of new variants of the virus and delays in the approval, distribution and administration of various vaccines, we cannot reasonably estimate the full extent or duration 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 February 27, 2021, our cash, cash equivalents, and short-term investments were $509.6 million. We also have access to significant borrowing capacity under our unsecured revolving credit facility, which we believe, together with our cash balances, will continue to help us manage the impacts of the COVID-19 pandemic on our business and address related liquidity needs. 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., 24 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. While unemployment levels have improved from their peak during the pandemic, such levels still remain high. 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. Please see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended August 29, 2020 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 the thirteen and twenty-six weeks ended February 27, 2021 and February 29, 2020. Thirteen weeks ended Twenty-six weeks ended (In thousands, except percentages) February 27, 2021 % of Revenues February 29, 2020 % of Revenues % Change February 27, 2021 % of Revenues February 29, 2020 % of Revenues % Change Revenues $ 449,764 100.0 % $ 464,600 100.0 % (3.2 )% $ 896,617 100.0 % $ 929,998 100.0 % (3.6 )% Operating expenses: Cost of revenues (1) 289,455 64.4 301,422 64.9 (4.0 ) 565,255 63.0 590,738 63.5 (4.3 ) Selling and administrative expenses (1) 93,329 20.8 93,080 20.0 0.3 182,032 20.3 183,608 19.7 (0.9 ) Depreciation and amortization 26,287 5.8 25,971 5.6 1.2 52,595 5.9 51,430 5.5 2.3 Total operating expenses 409,071 91.0 420,473 90.5 (2.7 ) 799,882 89.2 825,776 88.8 (3.1 ) Operating income 40,693 9.0 44,127 9.5 (7.8 ) 96,735 10.8 104,222 11.2 (7.2 ) Other income, net (1,447 ) (0.3 ) (1,636 ) (0.4 ) (11.6 ) (1,266 ) (0.1 ) (3,469 ) (0.4 ) (63.5 ) Income before income taxes 42,140 9.4 45,763 9.8 (7.9 ) 98,001 10.9 107,691 11.6 (9.0 ) Provision for income taxes 9,555 2.1 11,083 2.4 (13.8 ) 23,520 2.6 24,769 2.7 (5.0 ) Net income $ 32,585 7.2 % $ 34,680 7.5 % (6.0 )% $ 74,481 8.3 % $ 82,922 8.9 % (10.2 )% (1) Exclusive of depreciation on our property, plant and equipment and amortization on our intangible assets. 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, 25 to a variety of manufacturers, retailers and service companies. We have five reporting segments, U.S. and Canadian Rental and Cleaning, MFG, Specialty Garments, First Aid and Corporate. We refer to the U.S. and Canadian Rental and Cleaning, MFG, and Corporate reporting segments combined as our “Core Laundry Operations.” 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 results of operations may also be adversely impacted by the decline in the Canadian exchange rate. 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 October 23, 2019, we announced that we would be raising our quarterly dividend to $0.25 per share of Common Stock and to $0.20 per share of 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 our available cash or capacity under our 2021 Credit Agreement (as defined below) and may be suspended or discontinued at any time. As of February 27, 2021, we repurchased a total of 368,117 shares for an average price per share of $167.87 under the share repurchase program using cash on hand. During the thirteen and twenty-six weeks ended February 27, 2021, we repurchased 12,200 and 53,200 shares for an average price per share of $189.96 and $179.21, respectively. During the thirteen and twenty-six weeks ended February 29, 2020, we repurchased 20,500 and 71,100 shares for an average price per share of $206.34 and $199.77, respectively. In our fourth fiscal quarter of 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 February 27, 2021, we have capitalized $27.7 million related to this CRM project. The Company began deployment of our new CRM during the third quarter of fiscal 2021 and as such, commencement of depreciation will begin at that point. 26 Thirteen weeks ended February 27, 2021 compared with thirteen weeks ended February 29, 2020 Revenues (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Core Laundry Operations $ 398,235 $ 412,192 $ (13,957 ) (3.4 )% Specialty Garments 35,222 35,980 (758 ) (2.1 )% First Aid 16,307 16,428 (121 ) (0.7 )% Consolidated total $ 449,764 $ 464,600 $ (14,836 ) (3.2 )% Consolidated revenues during the second quarter of fiscal 2021 decreased compared to the prior year comparable period. The decrease was primarily driven by a decline in revenues in our Core Laundry Operations resulting from the continued impact of the COVID-19 pandemic on our customers’ operations and wearer levels. In addition, severe winter storms in Texas and the surrounding states during February 2021 contributed to the decline. Specialty Garments revenues in the second quarter of fiscal 2021 decreased compared to the prior year comparable period due primarily to decreased revenues from our U.S. and Canadian nuclear operations, which was partially offset by higher direct sales in our cleanroom operations. Specialty Garments’ results are often affected by seasonality and the timing and length of its customers’ power reactor outages as well as its project-based activities. First Aid revenues in the second quarter of fiscal 2021 decreased compared to the prior year comparable period due to reduced sales from the segment’s wholesale distribution business, which was partially offset by increased sales in our van business. Cost of Revenues (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Cost of revenues $ 289,455 $ 301,422 $ (11,967 ) (4.0 )% % of Revenues 64.4 % 64.9 % Core Laundry Operations cost of revenues as a percentage of revenues decreased in the second quarter of fiscal 2021 as compared to the prior year comparable period. This decrease was due primarily to lower merchandise costs and bad debt expense, which were partially offset by the impact of the severe winter storms in Texas and the surrounding states during February 2021 and higher healthcare claims costs. Specialty Garments cost of revenues as a percentage of revenues decreased in the second quarter of fiscal 2021 as compared to the prior year comparable period due primarily to higher gross margin on its direct sales. Selling and Administrative Expenses (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Selling and administrative expenses $ 93,329 $ 93,080 $ 249 0.3 % % of Revenues 20.8 % 20.0 % Our selling and administrative costs increased as a percentage of revenues in the second quarter of fiscal 2021 as compared to the prior year comparable period primarily due to the impact of the decline in rental revenues on our cost structure as well as an increase in selling and administrative payroll expense and healthcare claims costs. These increases were primarily offset by lower travel-related and legal costs. 27 Depreciation and Amortization (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Depreciation and amortization $ 26,287 $ 25,971 $ 316 1.2 % % of Revenues 5.8 % 5.6 % Depreciation and amortization expense increased in the second quarter of fiscal 2021 as compared to the prior year comparable period due primarily to higher capital expenditures placed in service over the previous quarters. The increase in depreciation and amortization reflects our continued capital investments in the business. Operating Income For the thirteen weeks ended February 27, 2021 and February 29, 2020, changes in our revenues and costs as discussed above resulted in the following changes in our operating income and margin: (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Core Laundry Operations $ 35,366 $ 38,357 $ (2,991 ) (7.8 )% Specialty Garments 5,234 4,627 607 13.1 % First Aid 93 1,143 (1,050 ) (91.9 )% Operating income $ 40,693 $ 44,127 $ (3,434 ) (7.8 )% Operating income margin 9.0 % 9.5 % Other Income, net (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Interest income, net $ (863 ) $ (2,175 ) $ 1,312 (60.3 )% Other expense, net (584 ) 539 (1,123 ) (208.3 )% Total other income, net $ (1,447 ) $ (1,636 ) $ 189 (11.6 )% The decrease in other income, net during the second quarter of fiscal 2021 as compared to the prior year comparable period was due primarily to lower interest income from declining interest rates, which was partially offset by increased foreign exchange gains. Provision for Income Taxes (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Provision for income taxes $ 9,555 $ 11,083 $ (1,528 ) (13.8 )% Effective income tax rate 22.7 % 24.2 % The decrease in our effective tax rate for the second quarter of fiscal 2021 as compared to the prior year comparable period was due primarily to an increase in a discrete benefit related to stock-based compensation payments. Twenty-six weeks ended February 27, 2021 compared with twenty-six weeks ended February 29, 2020 Revenues (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Core Laundry Operations $ 791,425 $ 828,490 $ (37,065 ) (4.5 )% Specialty Garments 73,356 69,382 3,974 5.7 % First Aid 31,836 32,126 (290 ) (0.9 )% Consolidated total $ 896,617 $ 929,998 $ (33,381 ) (3.6 )% 28 Consolidated revenues during the twenty-six weeks ended February 27, 2021 decreased compared to the prior year comparable period. The decrease was primarily driven by a decline in revenues in our Core Laundry Operations resulting from the continued impact of the COVID-19 pandemic on our customers’ operations and wearer levels. Specialty Garments revenues during the twenty-six weeks ended February 27, 2021increased compared to the prior year comparable period due primarily to growth in our cleanroom operations, which was partially offset by decreased revenues from our U.S. and Canadian nuclear operations. Specialty Garments’ results are often affected by seasonality and the timing and length of its customers’ power reactor outages as well as its project-based activities. First Aid revenues during the twenty-six weeks ended February 27, 2021 decreased compared to the prior year comparable period due to reduced sales from the segment’s wholesale distribution business, which was partially offset by increased sales in our van business. Cost of Revenues (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Cost of revenues $ 565,255 $ 590,738 $ (25,483 ) (4.3 )% % of Revenues 63.0 % 63.5 % Core Laundry Operations cost of revenues as a percentage of revenues decreased during the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period. This decrease was due primarily to lower merchandise costs and bad debt expense, which were partially offset by the impact of the severe winter storms in Texas and the surrounding states during February 2021 as well as higher healthcare claims costs. Specialty Garments cost of revenues as a percentage of revenues decreased during the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period due primarily to lower production and services costs as a percentage of revenue. These decreases were partially offset by increased merchandise costs as a percentage of revenue. Selling and Administrative Expenses (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Selling and administrative expenses $ 182,032 $ 183,608 $ (1,576 ) (0.9 )% % of Revenues 20.3 % 19.7 % Our selling and administrative costs as a percentage of revenues increased during the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period primarily due to the impact of the decline in rental revenues on our cost structure as well as an increase in selling and administrative payroll expense. These increases were primarily offset by lower travel-related and legal costs. Depreciation and Amortization (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Depreciation and amortization $ 52,595 $ 51,430 $ 1,165 2.3 % % of Revenues 5.9 % 5.5 % Depreciation and amortization expense increased during the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period due primarily to higher capital expenditures placed in service over the previous quarters. The increase in depreciation and amortization reflects our continued capital investments in the business. Operating Income For the twenty-six weeks ended February 27, 2021 and February 29, 2020, changes in our revenues and costs as discussed above resulted in the following changes in our operating income and operating income margin: 29 (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Core Laundry Operations $ 84,236 $ 92,165 $ (7,929 ) (8.6 )% Specialty Garments 12,393 9,506 2,887 30.4 % First Aid 106 2,551 (2,445 ) (95.8 )% Operating income $ 96,735 $ 104,222 $ (7,487 ) (7.2 )% Operating income margin 10.8 % 11.2 % Other Income, net (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Interest income, net $ (1,431 ) $ (4,536 ) $ 3,105 (68.5 )% Other expense, net 165 1,067 (902 ) (84.5 )% Total other income, net $ (1,266 ) $ (3,469 ) $ 2,203 (63.5 )% The decrease in other income, net during the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period was due primarily to lower interest income from declining interest rates, which was partially offset by increased foreign exchange gains. Provision for Income Taxes (In thousands, except percentages) February 27, 2021 February 29, 2020 Dollar Change Percent Change Provision for income taxes $ 23,520 $ 24,769 $ (1,249 ) (5.0 )% Effective income tax rate 24.0 % 23.0 % The increase in our effective tax rate during the twenty-six weeks ended February 27, 2021 was due primarily to a $1.3 million benefit in the prior year comparable period resulting from the release of certain tax reserves. Liquidity and Capital Resources General Cash, cash equivalents and short-term investments totaled $509.6 million as of February 27, 2021, an increase of $114.2 million from February 29, 2020 when the amount totaled $395.3 million. We generated $128.0 million and $136.9 million in cash from operating activities in the twenty-six weeks ended February 27, 2021 and February 29, 2020, respectively. Pursuant to a share repurchase program approved by our Board of Directors on January 2, 2019, we repurchased 53,200 shares of our Common Stock for an aggregate of approximately $9.5 million during the twenty-six weeks ended February 27, 2021. We believe, although there can be no assurance, that our current cash, cash equivalents and short-term investments balances, our cash generated from future operations and amounts available under our 2021 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. 30 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 and stock repurchases . 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. Sources and uses of cash flows for the twenty-six weeks ended February 27, 2021 and February 29, 2020, respectively, are summarized as follows: (In thousands, except percentages) February 27, 2021 February 29, 2020 Percent Change Net cash provided by operating activities $ 128,016 $ 136,869 (6.5 )% Net cash used in investing activities (73,592 ) (103,056 ) (28.6 )% Net cash used in financing activities (21,243 ) (24,018 ) (11.6 )% Effect of exchange rate changes 1,544 187 725.7 % Net decrease in cash, cash equivalents and short-term investments $ 34,725 $ 9,982 247.9 % Net Cash Provided by Operating Activities The net cash provided by operating activities during the twenty-six weeks ended February 27, 2021 decreased as compared to the prior year comparable period due primarily to a decrease in revenue driving lower net income, increased inventory expenditures, and increased accounts receivable due to the impact of COVID-19. These decreases were partially offset by the deferral of United States social security and Medicare taxes under the Coronavirus Aid, Relief, and Economic Security Act (the “Cares Act”). Net Cash Used in Investing Activities The net decrease in cash used in investing activities was due primarily to the acquisition of a Missouri-based industrial laundry business, which was completed in the thirteen weeks ended November 30, 2019 for $38.8 million, using available cash on hand. Net Cash Used in Financing Activities The decrease in cash used in financing activities was due primarily to a decrease in the repurchase of Common Stock of $4.7 million and a decrease in the cash paid for taxes withheld related to net share settlement of equity awards in the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period. These decreases were partially offset by an increase in dividends paid of $2.5 million in the twenty-six weeks ended February 27, 2021 as compared to the prior year comparable period. Long-Term Debt and Borrowing Capacity On March 26, 2021, we entered into an amended and restated $175.0 million unsecured revolving credit agreement (the “2021 Credit Agreement”) with a syndicate of banks, which matures on March 26, 2026. The 2021 Credit Agreement amended and restated our prior Credit Agreement, which was scheduled to mature on April 11, 2021. Under the 2021 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 the Company’s 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 2021 Credit Agreement. Prior to March 26, 2021, we had a $250 million unsecured revolving credit agreement (the “Credit Agreement”) with a syndicate of banks, which was scheduled to mature on April 11, 2021. Under the Credit Agreement, we were 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 required 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 tested our compliance with these financial covenants on a fiscal quarterly basis. As of February 27, 2021, 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 February 27, 2021, we had no outstanding borrowings and had outstanding letters of credit amounting to $67.5 million, leaving $182.5 million available for borrowing under the Credit Agreement. As of February 27, 2021, we were in compliance with all covenants under the Credit Agreement. 31 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 the 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 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 February 27, 2021, we had forward contracts with a notional value of approximately $3.0 million CAD outstanding and recorded the fair value of the contracts of a nominal amount in other long-term assets and prepaid expenses and other current assets with a corresponding nominal gain in accumulated other comprehensive loss, which was recorded net of tax. During the twenty-six weeks ended February 27, 2021, we reclassified a nominal amount from accumulated other comprehensive income to revenue, related to the derivative financial instruments. The gain on these forward contracts that resulted in a decrease to accumulated other comprehensive loss as of February 27, 2021 is expected to be reclassified to revenues prior to its maturity on February 25, 2022. Commitments and 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 wastewater 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 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, together with multiple other companies, are party to a consent decree related to our property and other parcels of land (the “Central Area”) at a site in Woburn, Massachusetts. 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. The consent decree does not address any remediation work that may be required 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 continues to monitor environmental conditions at the Somerville, Massachusetts site. 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. 32 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; • 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 February 27, 2021, the risk-free interest rates we utilized ranged from 1.4% to 2.2%. 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 twenty-six weeks ended February 27, 2021 were as follows (in thousands): February 27, 2021 Balance as of August 29, 2020 $ 30,702 Costs incurred for which reserves have been provided (556 ) Insurance proceeds 67 Interest accretion 224 Changes in discount rates (1,654 ) Balance as of February 27, 2021 $ 28,783 Anticipated payments and insurance proceeds relating to currently identified environmental remediation liabilities as of February 27, 2021, for the next five fiscal years and thereafter, as measured in current dollars, are reflected below. (In thousands) 2021 2022 2023 2024 2025 Thereafter Total Estimated costs – current dollars $ 10,812 $ 2,668 $ 1,371 $ 1,073 $ 1,076 $ 11,852 $ 28,852 Estimated insurance proceeds (130 ) (159 ) (173 ) (159 ) (173 ) (521 ) (1,315 ) Net anticipated costs $ 10,682 $ 2,509 $ 1,198 $ 914 $ 903 $ 11,331 $ 27,537 Effect of inflation 7,475 Effect of discounting (6,229 ) Balance as of February 27, 2021 $ 28,783 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 in Williamstown, Vermont. 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 February 27, 2021, 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 the site in Uvalde, Texas. 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. 33 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 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. Off-Balance Sheet Arrangements As of February 27, 2021, 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, customer agreements that generally provide for price increases consistent with the rate of inflation and continued focus on improvements of operational productivity. Contractual Obligations and Other Commercial Commitments As of February 27, 2021, there were no material changes to our contractual obligations that were disclosed in our Annual Report on Form 10-K for the year ended August 29, 2020. Recent Accounting Pronouncements See Note 2, “Recent Accounting Pronouncements” to our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for more information on recently implemented and issued accounting standards. 34 ITEM 3. QUANTITATIVE AND QUALITATI VE DISCLOSURES ABOUT MARKET RISK Foreign Currency Exchange Risk We have determined that all of our foreign subsidiaries operate primarily in local currencies that represent the functional currencies of such subsidiaries. All assets and liabilities of our foreign subsidiaries are translated into U.S. dollars using the exchange rate prevailing at the balance sheet date. The effects of exchange rate fluctuations on the translation of assets and liabilities are recorded as a component of shareholders’ equity. Revenues and expenses are translated at the average exchange rates in effect during each month of the fiscal year. As such, our financial condition and operating results are affected by fluctuations in the value of the U.S. dollar as compared to currencies in foreign countries. Revenues denominated in currencies other than the U.S. dollar represented approximately 8.4% and 8.2% of total consolidated revenues for the thirteen and twenty-six weeks ended February 27, 2021, respectively. Total assets denominated in currencies other than the U.S. dollar represented approximately 6.8% and 6.7% of total consolidated assets as of February 27, 2021 and August 29, 2020, respectively. If exchange rates had increased or decreased by 10% from the actual rates in effect during each of the thirteen and twenty-six weeks ended February 27, 2021, our revenues would have increased or decreased by approximately $5.7 million and $10.8 million, respectively, and total assets as of February 27, 2021 would have increased or decreased by approximately $15.4 million. 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 the 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 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 February 27, 2021, we had forward contracts with a notional value of approximately $3.0 million CAD outstanding and recorded the fair value of the contracts of a nominal amount in other long-term assets and prepaid expenses and other current assets with a corresponding nominal gain in accumulated other comprehensive loss, which was recorded net of tax. During the twenty-six weeks ended February 27, 2021, we reclassified a nominal amount from accumulated other comprehensive income to revenue, related to the derivative financial instruments. The gain on these forward contracts that resulted in a decrease to accumulated other comprehensive loss as of February 27, 2021 is expected to be reclassified to revenues prior to its maturity on February 25, 2022. Other than the forward contracts, discussed above, we do not operate a hedging program to mitigate the effect of a significant change in the value of the functional currencies of our foreign subsidiaries, which include the Canadian dollar, euro, British pound, Mexican peso and Nicaraguan cordoba, as compared to the U.S. dollar. Any losses or gains resulting from unhedged foreign currency transactions, including exchange rate fluctuations on intercompany accounts are reported as transaction losses (gains) in our other income, net. The intercompany payables and receivables are denominated in Canadian dollars, euros, British pounds, Mexican pesos and Nicaraguan cordobas. During the thirteen and twenty-six weeks ended February 27, 2021, transaction gains of $1.1 million and $0.8 million, respectively, were included in other income. If exchange rates had increased or decreased by 10% during each of the thirteen and twenty-six weeks ended February 27, 2021, we would have recognized exchange gains or losses of approximately $0.1 million. Please see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended August 29, 2020 for an additional discussion of risks and potential risks of the COVID-19 pandemic on our business, financial performance and the market price of our Common Stock.