Item 2. Management’s Discussion and Analysis
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 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 “Part I, Item 1A. Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended August 28, 2021 and in our other filings with the Securities and Exchange Commission, including, without limitation, under “Part II, 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.
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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 28, 2021.
COVID-19 Assessment
The global COVID-19 pandemic continues to impact the countries in which we operate. Developments continue to occur rapidly, including the recent emergence and spread of new COVID-19 variants. Our revenues in the first half of fiscal 2021 were significantly adversely impacted as a result of many customers closing their businesses or operating at limited capacities. If customers were to again be forced to close or limit operations as 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 COVID-19 variants, 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 November 27, 2021, our cash, cash equivalents, and short-term investments were $478.1 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.
Please see “Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended August 28, 2021 for an additional discussion of risks and potential risks of the COVID-19 pandemic on our business, financial condition and results of operations.
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Results of Operations
The following table presents certain selected financial data, including the percentage of revenues represented by each item, for the thirteen weeks ended November 27, 2021 and November 28, 2020.
Thirteen weeks ended
(In thousands, except percentages)
November 27, 2021
% of
Revenues
November 28, 2020
% of
Revenues
%
Change
Revenues
$
486,164
100.0
%
$
446,853
100.0
%
8.8
%
Operating expenses:
Cost of revenues (1)
310,130
63.8
275,800
61.7
12.4
Selling and administrative expenses (1)
104,388
21.5
88,703
19.9
17.7
Depreciation and amortization
26,856
5.5
26,308
5.9
2.1
Total operating expenses
441,374
90.8
390,811
87.5
12.9
Operating income
44,790
9.2
56,042
12.5
(20.1
)
Other expense, net
88
0.0
181
0.0
(51.4
)
Income before income taxes
44,702
9.2
55,861
12.5
(20.0
)
Provision for income taxes
10,997
2.3
13,965
3.1
(21.3
)
Net income
$
33,705
6.9
%
$
41,896
9.4
%
(19.6
)%
(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, 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.
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 have increased recently 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.
In fiscal 2018, we initiated a multiyear CRM project to further develop, implement and deploy a third-party application we licensed. This new solution improves functionality, capability and information flow as well as increases automation in servicing our customers. As of November 27, 2021, we have capitalized $35.9 million related to this CRM project. We began deployment of our new CRM project during the second half of fiscal 2021 and anticipate this will continue through fiscal 2022 and 2023. We are depreciating this system over a 10-year life and recognized $0.7 million of amortization expense during the thirteen weeks ended November 27, 2021.
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Thirteen weeks ended November 27, 2021 compared with thirteen weeks ended November 28, 2020
Revenues
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Core Laundry Operations
$
428,846
$
393,190
$
35,656
9.1
%
Specialty Garments
39,484
38,134
1,350
3.5
%
First Aid
17,834
15,529
2,305
14.8
%
Consolidated total
$
486,164
$
446,853
$
39,311
8.8
%
Core Laundry Operations’ revenues during the first quarter of fiscal 2022 increased compared to the prior year comparable period. Core Laundry Operations’ organic growth, which adjusts for the estimated effect of acquisitions as well as fluctuations in the Canadian dollar, was 8.6%. This strong organic growth rate was primarily the result of customer reopenings, solid sales performance and improved customer retention in the first quarter of fiscal 2022 as well as efforts to share with our customers the cost increases that we are seeing in our business due to the current inflationary environment.
Specialty Garments revenues in the first quarter of fiscal 2022 increased compared to the prior year comparable period due primarily to growth in the cleanroom and European nuclear operations partially offset by a decrease in the US 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 in the first quarter of fiscal 2022 increased compared to the prior year comparable period due to growth in both our van and wholesale distribution businesses.
Cost of Revenues
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Cost of revenues
$
310,130
$
275,800
$
34,330
12.4
%
% of Revenues
63.8
%
61.7
%
Core Laundry Operations’ cost of revenues as a percentage of revenues increased in the first quarter of fiscal 2022 as compared to the prior year comparable period. This increase was due primarily to higher merchandise, production payroll, energy and labor costs as a percentage of revenues. In addition, we had elevated expense related to internal use safety supplies compared to the prior year comparable period.
Specialty Garments cost of revenues as a percentage of revenues decreased in the first quarter of fiscal 2022 as compared to the prior year comparable period. This decrease was due primarily to lower merchandise and other production costs as percentages of revenue partially offset by higher production payroll and transportation costs as percentages of revenue.
Selling and Administrative Expenses
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Selling and administrative expenses
$
104,388
$
88,703
$
15,685
17.7
%
% of Revenues
21.5
%
19.9
%
Our selling and administrative costs increased as a percentage of revenues in the first quarter of fiscal 2022 as compared to the prior year comparable period due primarily to increased general and administrative payroll costs to advance our capabilities and costs directly attributable to our CRM, ERP and branding initiatives. Also contributing to the increase were increased healthcare claims, travel costs and indirect taxes.
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Depreciation and Amortization
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Depreciation and amortization
$
26,856
$
26,308
$
548
2.1
%
% of Revenues
5.5
%
5.9
%
Depreciation and amortization expense increased in the first quarter of fiscal 2022 as compared to the prior year comparable period due primarily to continued investment in our infrastructure as well as our key technology initiatives. The higher expense includes amortization of $0.7 million for our new CRM project that we began to deploy in the second half of fiscal 2021.
Operating Income
For the thirteen weeks ended November 27, 2021 and November 28, 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)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Core Laundry Operations
$
36,507
$
48,870
$
(12,363
)
(25.3
)%
Specialty Garments
8,629
7,159
1,470
20.5
%
First Aid
(346
)
13
(359
)
(2761.5
)%
Operating income
$
44,790
$
56,042
$
(11,252
)
(20.1
)%
Operating income margin
9.2
%
12.5
%
Other Expense, net
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Interest income, net
$
(648
)
$
(568
)
$
(80
)
14.1
%
Other expense, net
736
749
(13
)
(1.7
)%
Total other expense, net
$
88
$
181
$
(93
)
(51.4
)%
Other expense, net during the first quarter of fiscal 2022 remained relatively consistent with the prior year comparable period.
Provision for Income Taxes
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Dollar
Change
Percent
Change
Provision for income taxes
$
10,997
$
13,965
$
(2,968
)
(21.3
)%
Effective income tax rate
24.6
%
25.0
%
The decrease in our effective tax rate for the first quarter of fiscal 2022 as compared to the prior year comparable period was due primarily to the impact of an increased tax benefit related to the foreign derived intangible income deduction.
Liquidity and Capital Resources
General
Cash, cash equivalents and short-term investments totaled $478.1 million as of November 27, 2021, an increase of $5.1 million from November 28, 2020 when the amount totaled $473.0 million. We generated $7.8 million and $52.7 million in cash from operating activities in the thirteen weeks ended November 27, 2021 and November 28, 2020, respectively.
Pursuant to share repurchase programs approved by our Board of Directors on January 2, 2019 and October 18, 2021, we repurchased 22,750 shares of our Common Stock for an aggregate of approximately $4.8 million during the thirteen weeks ended November 27, 2021, of which $4.6 million was paid during the period.
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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.
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 thirteen weeks ended November 27, 2021 and November 28, 2020, respectively, are summarized as follows:
(In thousands, except percentages)
November 27, 2021
November 28, 2020
Percent
Change
Net cash provided by operating activities
$
7,822
$
52,741
(85.2
)%
Net cash used in investing activities
(31,517
)
(42,424
)
(25.7
)%
Net cash used in financing activities
(9,858
)
(12,590
)
(21.7
)%
Effect of exchange rate changes
(1,254
)
445
(381.8
)%
Net decrease in cash, cash equivalents and
short-term investments
$
(34,807
)
$
(1,828
)
1804.1
%
Net Cash Provided by Operating Activities
The net cash provided by operating activities during the thirteen weeks ended November 27, 2021 decreased as compared to the prior year comparable period due primarily to increases in inventories, rental merchandise in service and accounts receivable. Also contributing to the decrease were decreases in net income and accrued liabilities. The elevated inventories related to the ongoing supply chain disruption and the increased merchandise in service are attributable to our balance sheet position continuing to normalize coming out of the COVID-19 pandemic impacted period. The increase in rental merchandise in service and accounts receivable was due to the increased revenue from the economic recovery from the earlier impacts of the COVID-19 pandemic. The decrease in accrued liabilities was due primarily to $7.9 million of the employer portion of U.S. social security taxes that we elected to defer paying in the first quarter of fiscal 2021 under the U.S. CARES Act. These items causing a decrease to the net cash provided by operating activities were partially offset by a decrease in prepaid and accrued income taxes due primarily to overpayments of taxes made in fiscal 2021 that were applied to estimated tax payments in the first quarter of fiscal 2022.
Net Cash Used in Investing Activities
The net decrease in cash used in investing activities during the thirteen weeks ended November 27, 2021 was due primarily to lower capital expenditures and capitalization of software costs of $10.8 million.
Net Cash Used in Financing Activities
The decrease in net cash used in financing activities was due primarily to a $2.6 million decrease in the repurchase of Common Stock in the thirteen weeks ended November 27, 2021 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 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 2021 Credit Agreement. We test our compliance with these financial covenants on a fiscal quarterly basis. As of November 27, 2021, the interest rates applicable to our borrowings under the 2021 Credit Agreement would be calculated as LIBOR plus 1.00% at the time of the respective borrowing. As of November 27, 2021, we had no outstanding borrowings and had outstanding letters of credit amounting to $67.5 million, leaving $107.5 million available for borrowing under the 2021 Credit Agreement.
As of November 27, 2021, we were in compliance with all covenants under the 2021 Credit Agreement.
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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.
In August 2021, we entered into twenty 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 each fiscal quarter, beginning in the first fiscal quarter of 2022 and continuing through the fourth fiscal quarter of 2026. In total, we will sell approximately 14.1 million CAD at an average Canadian-dollar exchange rate of 0.7861 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 November 27, 2021, we had forward contracts with a notional value of approximately 11.5 million CAD outstanding and recorded the fair value of the contracts of $0.1 million in prepaid expenses and other current assets and other long-term assets with a corresponding gain in accumulated other comprehensive loss of $0.1 million, which was recorded net of tax. During the thirteen weeks ended November 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 November 27, 2021 is expected to be reclassified to revenues prior to their maturities on February 25, 2022 and August 29, 2026, respectively.
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 continue to monitor environmental conditions at the Somerville, Massachusetts site. We have agreed to undertake additional actions responsive to a notice of audit findings from the Massachusetts Department of Environmental
26
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;
•
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 November 27, 2021, the risk-free interest rates we utilized ranged from 0.81% to 1.89%.
For environmental liabilities that have been discounted, we include interest accretion, based on the effective interest method, in selling and administrative expenses on the accompanying Consolidated Statements of Income. The changes to the amounts of our environmental liabilities for the thirteen weeks ended November 27, 2021 were as follows (in thousands):
November 27, 2021
Balance as of August 28, 2021
$
32,859
Costs incurred for which reserves have been provided
(374
)
Insurance proceeds
41
Interest accretion
149
Changes in discount rates
160
Balance as of November 27, 2021
$
32,835
Anticipated payments and insurance proceeds relating to currently identified environmental remediation liabilities as of November 27, 2021, for the next five fiscal years and thereafter, as measured in current dollars, are reflected below.
(In thousands)
2022
2023
2024
2025
2026
Thereafter
Total
Estimated costs – current dollars
$
12,116
$
2,530
$
2,080
$
1,366
$
1,129
$
12,712
$
31,933
Estimated insurance proceeds
(169
)
(159
)
(173
)
(159
)
(173
)
(380
)
(1,213
)
Net anticipated costs
$
11,947
$
2,371
$
1,907
$
1,207
$
956
$
12,332
$
30,720
Effect of inflation
8,061
Effect of discounting
(5,946
)
Balance as of November 27, 2021
$
32,835
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 November 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 $4.7 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 respective state agencies, as delegated authority by the Nuclear Regulatory Commission (the “NRC”) pursuant to the NRC’s Agreement State program and are subject to applicable federal and state radioactive material regulations. In addition, our international locations (Canada, the United Kingdom and the European Union) are
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regulated by equivalent respective jurisdictional authorities. There can be no assurance that such regulation will not lead to material disruptions in the Company’s 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 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 November 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. However, the current inflationary environment has had a negative impact on our margins and we expect that it will continue to pressure our margins in future periods.
Contractual Obligations and Other Commercial Commitments
As of November 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 28, 2021.
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.
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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% of total consolidated revenues for the thirteen weeks ended November 27, 2021. Total assets denominated in currencies other than the U.S. dollar represented approximately 6.9% and 7.0% of total consolidated assets as of November 27, 2021 and August 28, 2021. If exchange rates had increased or decreased by 10% from the actual rates in effect during the thirteen weeks ended November 27, 2021, our revenues would have increased or decreased by approximately $4.1 million and, respectively, and total assets as of November 27, 2021 would have increased or decreased by approximately $16.6 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.
In August 2021, we entered into twenty forward contracts to exchange CAD for U.S. dollars at fixed exchange rates in order to manage its exposure related to certain forecasted CAD denominated sales of one of its subsidiaries. The hedged transactions are specified as the first amount of CAD denominated revenues invoiced by one of the Company’s domestic subsidiaries each fiscal quarter, beginning in the first fiscal quarter of 2022 and continuing through the fourth fiscal quarter of 2026. In total, the Company will sell approximately 14.1 million CAD at an average Canadian-dollar exchange rate of 0.7861 over these quarterly periods. The Company concluded that the forward contracts met the criteria to qualify as a cash flow hedge under U.S. GAAP.
As of November 27, 2021, we had forward contracts with a notional value of approximately 11.5 million CAD outstanding and recorded the fair value of the contracts of $0.1 million in prepaid expenses and other current assets and other long-term assets with a corresponding gain in accumulated other comprehensive loss of $0.1 million, which was recorded net of tax. During the thirteen weeks ended November 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 November 27, 2021 is expected to be reclassified to revenues prior to its maturity on February 25, 2022 and August 29, 2026, respectively.
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 weeks ended November 27, 2021, transaction gains of $0.5 million were included in other expense, net. If exchange rates had increased or decreased by 10% during the thirteen weeks ended November 27, 2021, we would have recognized exchange gains or losses of approximately $0.2 million.
Please see “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended August 28, 2021 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.
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