Aramark (ARMK) 2004 Q2 法說會逐字稿

Good morning, and welcome, ladies and gentlemen, to the ARAMARK Corporation Second Quarter Fiscal 2004 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are on a listen-only mode. At the request of the Company, we will open up the conference up for questions and answers after the presentation.

I will now turn the conference over to Gary Sender, Vice President, Investor Relations. Please go ahead, sir.

Thank you, and welcome to ARAMARK Corporation's conference call to review the results of our second quarter of fiscal of 2004. Here with me today are Joe Neubauer, ARAMARK's Executive Chairman; Bill Leonard, the Company's President and Chief Executive Officer; and Fred Sutherland, our Executive Vice President and Chief Financial Officer.

Joe, Bill, and Fred will present an overview of our second quarter results and business operations, after which there will be an opportunity for phone-in participants to ask questions. Before we begin, however, a few housekeeping matters.

As we discuss the results for the quarter, you may want to refer to the financial statements attached to this morning's press release, which can be found on our website at www.ARAMARK.com.

In the earnings press release and in today's discussion of results, we mention certain financial measures that are considered non-GAAP. Generally, a non-GAAP financial measure is a numerical measure of a Company's performance, financial position, or cash flow that either excludes or includes items different than those prepared or presented in accordance with Generally Accepted Accounting Principles.

The Investor Relations section of the Company's website includes a disclosure and reconciliation of non-GAAP financial measures that will be used in this webcast conference call and may be used periodically by management when discussing the Company's financial results with investors and analysts.

Any recording or other use or transmission of this audio may not be done without the prior written consent of ARAMARK.

Various remarks that we may make in this call relating to matters that are not historical facts, including remarks about future expectations, anticipations, beliefs, estimates, plans, and prospects for ARAMARK, constitute forward-looking statements for purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various risks, uncertainties, and important factors, including those discussed in the Risk Factors section in the Management's Discussion, and Analysis of Results of Operations and Financial Conditions sections and other sections of ARAMARK's 2003 Form 10-K and Form 10-Qs filed with the Securities and Exchange Commission.

We disclaim any duty to update or revise such forward-looking statements whether as a result of new information, future events, or otherwise.

I will now turn the program over to Bill Leonard. Bill?

Good morning, and thank you all for taking the time to join us today.

I'm pleased to discuss our second quarter and year-to-date results as they demonstrate solid improvement in organic sales growth rates and the continued execution of our Mission One strategy.

I'm going to cover our consolidated results for the second quarter and let Fred Sutherland discuss in detail the results of our individual business segments and other financial matters.

In light of the number of new comprehensive healthcare clients we've signed on in the last year, I thought it would be informative for me to describe their start-up procedures, so I'll get into some detail on this topic.

Let's start with the results.

Second quarter sales were $2.5b, up 12 percent from a year ago. Overall organic sales growth was 7 percent. Organic sales growth was about 7 percent for our worldwide Food and Support Services business and 3 percent for Uniform Services. We measure organic sales growth by adjusting for acquisitions, divestitures, currency impacts, and the effect of a timing adjustment related to the calendar shift, similar to 2004's first fiscal quarter.

We are particularly pleased that we are seeing organic sales growth across the board in both economically sensitive and non-sensitive businesses for the quarter.

For the first half of 2004, we have delivered 5-percent overall organic sales growth, comprised of 6 percent in our worldwide Food and Support Services operations and 1 percent in our Uniform segments, and the overall trend in organic sales growth is improving.

Second quarter income from continuing operations was up 23 percent year over year to $46.7m, while year-to-date income from continuing operations is up 18 percent to $114m.

Second quarter diluted earnings per share from continuing operations was 24 cents, up 26 percent over the same quarter last year, and EPS is up 23 percent year to date.

Internally, we measure cash flow generated by our businesses before working capital and after capital expenditures. This metric, which we define as income from continuing operations, excluding unusual items, plus non-cash charges, such as depreciation, amortization, and deferred taxes, less all capital expenditures for the first half of the year, was $143m, up 12 percent versus prior year.

Net new business sold in the first six months is up over prior year. Our retention rates continue to run at high levels, although our lost business for the first six months is also up over last year's low rate. Mission One continues to positively affect our progress. It's important to emphasize that Mission One is a multi-year formalized company-wide activity with planned efforts and continuous progress reports that enable us to hone our tactics.

We have identified over 150 top service expansion opportunities within our food and facilities businesses and have conducted a joint strategy session for each of these [across the line][ph] of business opportunities. The sessions include senior management members from each of our businesses and their sales teams. This represents a major part of ARAMARK's Mission One effort.

Within our Uniform, Office, Coffee and Vending service groups, where the average account size is fairly small, we are maintaining strong activity in terms of leads being fed from our existing field operations. Almost 300 potential opportunities were channeled to these businesses in the last quarter alone. Our overall Lead Exchange program experienced a sizable increase in the second quarter over the first quarter.

This year, Mission One sales are stronger than last year, and year to date, they represent about 25 percent of our annualized food and support services' new sales. I think that's just terrific.

ARAMARK also continues with programs to educate our front-line managers about our multi-service capabilities. Last quarter, I described these STAR teams, which are comprised of ARAMARK managers in the largest metropolitan areas regardless of their business unit. Corporate resources are now being put in place to support the efforts of over 30 star teams. As a result of these efforts, involvement with local ARAMARK employees and clients has significantly with events consistently involving hundreds of participants. Functions vary but always include clients, employees, and charitable events, as well as trade shows that demonstrate ARAMARK's comprehensive capabilities. We believe that due to these actions, as well as those of our sales team's objectives, we are well on our way to achieve our stated long-term objective of 6-to 8-percent organic sales growth, and I applaud our over 200,000-plus employees for embracing all of our Mission One initiatives.

As you're aware, we've been fortunate to have been selected to provide a complete set of services to some large healthcare organizations in the past year. We were delighted to have been awarded three contracts with almost $90m of annual business in the last 12 months, including the Scott & White Healthcare System, Mount Sinai Hospital, and Evanston Northwestern Hospital. Even better, these are contracts of up to 10 years in length.

However, we incur a significant investment in people and training for the start-up of a new comprehensive healthcare client. Since multi-service client relationships are a key part of Mission One, I thought I'd share some insights on how we start up a large multi-service healthcare account.

Building a long-term partnership with our major new customers is one of our key objectives, so we first carefully select and recruit the key experienced ARAMARK management team. These people are typically relocated from other existing ARAMARK locations.

Once we've invested in our new management team and moved them to the new location, it's crucial that we communicate the values frequently and clearly to everyone involved in the transition to the ARAMARK way of providing service. This process is especially important for large multi-service client transitions that involve us taking over a large number, often several hundred, of our clients' employees.

We start by giving them an orientation to our culture and our expectations. We'll then offer and provide technical training and invest in our human resource systems to migrate employees to the ARAMARK payroll systems. Our management team goes on to review the healthcare systems' latest Independent Satisfaction Measurements since we commit to increase the quality of service levels. Once we assess the new client's baseline performance, we set the objectives to implement best practices to meet our shared goals. A key step in our start-up process is to conduct internal satisfaction surveys to monitor our performance and determine needs for improvement. In fact, ongoing monitoring of our implementation of services is our most time-intensive activity during this transition. That's because ultimately our clients' long-term satisfaction is our most important goal. We know that we have achieved our initial objectives when our client and our new employees are satisfied during and following the transition. We believe that it is important to invest in necessary levels of human resources and training efforts required to build long-term partnerships, even if it adversely affects short-term results. Our financial commitment in the initial phases often has a high price tag, but in the long run, it's what drives our strong organic sales growth and client retention.

Now, let me turn the program over to Fred Sutherland to discuss the financial results of our individual business segments and some new business wins. Fred?

Thanks, Bill.

As Bill said, we were pleased with the top- and bottom-line performance of the Company this quarter and year to date.

For the quarter, sales and operating income growth was 12 percent.

Diluted earnings per share from continuing operations in the second quarter of 2004 was 24 cents, compared to 19 cents in the second quarter of '03.

Year-to-date sales, operating income, and diluted earnings per share were up 10 percent, 9 percent, and 23 percent, respectively.

Sales for the second quarter of fiscal '04 in our largest segment, Food and Support Services U.S., were about $1.7b, a 9-percent increase over the prior-year quarter.

Organic sales growth for the quarter was 7 percent. Year-to-date sales in this segment were up 8 percent, reflecting 5-percent organic sales growth.

To calculate organic sales growth, as Bill mentioned, we have adjusted for the positive impact on our education business of the calendar shift caused by last year's 53rd week. The 53rd week in fiscal 2003 shifted the start and ending dates of our fiscal '04 quarters, and this impacts quarter-to-quarter comparability.

Growth in the quarter also benefited somewhat from the calendar-shift impact on some of our other businesses, given that the New Year's holiday period fell into the first quarter this year rather than in the second fiscal quarter, as it did in 2003.

Our Business Services sector reported mid-single-digit organic sales growth for the quarter, while year-to-date organic sales growth was about 3 percent. The strength in the year-to-date figure was driven by net new business.

It's too early to speculate whether we have seen a meaningful improvement from the reported higher employment levels in any of our employment-sensitive businesses, although we are encouraged by what we've seen so far.

We were pleased to announce new contracts with Land O'Lakes and DaimlerChrysler.

Sales growth in the less economically sensitive Education sector was also in the mid-single digits for the quarter and for the year to date, due principally to base business growth. During the quarter, we signed agreements to provide food service for the University of Chicago, Wheaton College, and a large contract with the St. Louis School District.

The Sports and Entertainment sector posted organic sales growth in the mid-single digits for the quarter, principally due to the strength in our convention center business and a variety of special events we served during the quarter, including the Final Four NCAA Basketball Tournament and numerous activities during Super Bowl week, including the game itself, at Houston's Reliant Stadium. New business contracts include the Atlantic City Convention Center and the Tacoma Convention Center.

As we enter the summer travel season, expected sales and income for the balance of the year for our national parks and tourist attraction portfolio looks somewhat better than last year, although some of our national parks continue to be hampered by the drought conditions.

The baseball season has started out positively, with both attendance and per capita spending comparing favorably to last year.

The Healthcare and Corrections Food Service businesses, which, as you know, make up the "Other" sector, continued to report high single-digit sales growth this quarter. New accounts include Greenwood Leflore Hospital in Mississippi and the Essex County Adult and Juvenile Corrections Facility in New Jersey.

Facilities Services' organic sales growth continues to be robust, reporting a quarterly increase of just over 10 percent. New business includes East Baton Rouge Parish Schools, the Susquehanna Health System, and Facility Services here in Philadelphia at Citizens Bank Park, home of the Phillies.

Operating income in the domestic Food and Support Service segment was 61.1m, an 8-percent increase over the second quarter of '03. The operating income margin was equal to last year's second quarter margin.

New business opening and start-up costs, particularly in healthcare accounts, higher labor-related expenses, such as workers' compensation, state unemployment insurance, and medical benefits, and higher costs in our clinical healthcare business constrained profit growth somewhat in the current quarter.

Turning now to our Food and Support Services International segment, sales were about $475m in the second quarter of fiscal '04, 34 percent above sales for the same quarter last year, with currency translation accounting for about 17 percentage points of the inquiries. This segment reported organic sales growth in the high single digits for the quarter and mid-single digits year to date. All international operations reported at least mid-single-digit sales growth, and Canada, the U.K., and Spain had particularly strong growth. The integration of Catering Alliance, acquired in the U.K. earlier in the quarter, is proceeding on schedule.

Operating income in this segment for the second quarter of fiscal '04 increased about 35 percent to 23.1m from the 17m reported last year. Currency translation contributed about 18 percentage points. We continue to add new business in our international segment, with recent additions including Sears Canada, Terrassa Conference Center, and Hospital St. Augustine in Spain.

Turning to ARAMARK's Uniform and Career Apparel segments, let me cover the rental segment first.

Second quarter '04 sales of 260m were up 4 percent compared to the second quarter of '03. Organic sales growth was 3 percent, up from flat results in the first quarter. New business sold was 13 percent of the base, up slightly from the first quarter, with about half of the new sales coming from first-time users of rental programs. Lost business was about 8 percent, comparable to the results in the first quarter. About a third of the lost rental business came from accounts that simply went out of business. Price increases contributed about 1 to 2 percent, while base business declined about 4 percent due to the continued contraction at existing accounts. We are hopeful that this base business decline will improve as we move into the second half of '04.

Operating income of 26.7m in the second quarter was up about 9 percent from the prior-year quarter. We reported margin improvement of about 40 basis points compared to last year's second quarter. The benefit of higher sales and merchandise cost reductions were partially offset by higher labor-related expenses and increased energy costs.

We are again ramping up our sales force, which as we move forward will increase our sales expense. We expect these cost pressures to continue in the second half of the year, but we are still anticipating full-year margin improvement in our Uniform Rental operations.

In the Direct Marketing segment, sales for the second quarter increased 3 percent to $108.4m compared to the second quarter of '03. Both WearGuard and Galls experienced low single-digit organic sales growth, and operating income was up 4 percent.

Our net corporate expenses for the quarter of 8.5m were higher than the prior year, primarily due to the higher liability insurance premiums this year and a previously disclosed small divestiture gain, which was in 2003's second quarter.

Interest expense of 32.3m was down 2.8m, or 8 percent, versus the prior year due to lower effective rates and reduced borrowing levels. At quarter end, debt was about 1.9b compared to 1.7b at the end of fiscal '03. We expect interest expense to be about 31-33m per quarter for the second half of fiscal '04.

We recently renewed our revolving credit facility for five years. This 900m facility provides ample flexibility to fund internal needs and acquisitions. We achieved the best financing rates seen for a new five-year revolving bank credit facility of our credit rating at any time during the last five years, and we're clearly quite pleased with this result.

We were also pleased that Fitch upgraded our debt rating to straight BBB in April and that we were placed on positive credit watch by S&P back in December.

As Bill mentioned, our business continues to generate strong cash flows. In the first half of '04, internal cash flow, an operating metric that, as you'll recall, we define as income from continuing operations, excluding all unusual items, plus non-cash charges, such as depreciation, amortization, and deferred taxes, less all net capital expenditures, [indiscernible] 143m, compared to 128m last year.

Net capex for the first six months of '04 was $130m versus $107m last year, as we continue to invest in new business and in productivity improvements to modernize our uniform rental facilities.

Working capital for the first six months of '04, the usage was lower than the first half of '03.

Share repurchases in the second quarter totaled about 1.6m shares for $44.9m. Approximately 140m of our current share repurchase authorization remains.

For the third quarter, we expect sales to be between 2.5-2.6b and diluted earnings per share of 32 to 34 cents, compared to 31 cents in the third quarter of '03.

As a reminder, the 31-cents' quarterly EPS comparative number excludes the net impact of a two-cent-per-share gain last year, resulting from a four-cent-per-share tax settlement benefit that was partially offset by a two-cent-per-share debt extinguishment charge.

The third quarter expectation reflects the fact that our education business will have one less service week than in last year's third quarter, which is the final impact of last year's calendar shift, as well as some ongoing increased labor-related expenses and continuing start-up costs for large new contracts.

At this time, we'd like to also update our full-year guidance. We expect sales of between $9.9-10.1b, and this sales guidance reflects about 150m of additional sales from both acquisitions and the consolidation of our ownership from 20 percent to 51 percent of our Chilean affiliate, all of which we expect to be profit-neutral this year, as well as from currency translation, which has been clearly favorable this year, and from improved organic sales growth.

Our forecast for total company organic sales growth in '04 is now between 5 and 6 percent. We expect full-year earnings per share to be in the range of $1.40 to $1.44.

Now, let me turn it over to Joe Neubauer to wrap up.

Thank you, Fred.

I share Bill and Fred's satisfaction with the results that our organization has delivered in the second quarter. The updated sales estimate for the full year and the improvement in organic sales growth are encouraging and continue to validate our longer-term organic sales growth target of 6 to 8 percent. Although all of our markets remain quite competitive, we believe that we're well positioned to deliver our profitable growth targets.

Now, many of you have heard about our strategies to grow internationally. In addition to our ongoing organic growth activities, acquisitions and joint ventures also add a great deal of value to ARAMARK, particularly in new markets.

We recently announced that we increased our investment in Central de Restaurantes, our Chilean joint venture, from 20 to 51 percent. This is a solid business, and after getting to know the management team and their business culture for about three years, we were delighted to move to majority ownership recently. Last year, this company, which also operates in Argentina, registered sales of about $150m.

Now, aside from our fully consolidated international businesses, we have two large unconsolidated international joint ventures, which, frankly, don't get the airtime of our other overseas businesses.

In Japan, we have a 25-year partnership with Mitsui & Co., the country's second-largest company. Together, we've been growing that business both organically and through several acquisitions. The total sales now of this joint venture approaches about $1b, and they list Toyota, Sony, and Kyoto University Hospital among their premier clients. This 50/50 joint venture, known as AIM Services, is primarily focused on the B&I sector but is strategically moving into healthcare, as well as education.

The Japanese population is aging, and demand for healthcare is increasing, and we are bringing our best practices in serving healthcare clients to Japan, as well as several other international markets.

We like the global healthcare space because the outsourcing opportunities are significant. And given our superior healthcare service models, we are confident that we can add value to our international clients.

I just returned from a visit to our operations in Japan and Korea and was delighted by the quality of our activities and our growth prospects.

In Korea, where we initiated activities following the 1992 Olympics, we have a 100-percent-owned company with marquee clients, such as GM, Daewoo, and the [indiscernible] Convention Center.

We are significant players in both of these countries, and we see good opportunities for growth in other parts of Asia, including the growing market of China.

In Ireland, we've operated for three years in a joint venture with Campbell Catering, the largest food service provider in the Republic of Ireland. This venture, with revenues of about $150m, has a strong presence in the B&I public sector and education. We currently own 45 percent of Campbell Catering, and we intend to increase our ownership to majority status in the near future.

Quite frankly, we like the minority joint venture strategy of entering a new country. It allows us to partner with a leading local firm, install some ARAMARK management and best practices, and provides a reasonable period of time to ensure that we can have a premier service organization operating in a manner consistent with our values. It's also a great way to preserve local management involvement, which is important to maintaining established relationships.

Ravi Saligram, an experienced international executive, joined us last year, and he's doing a great job as our International President. Some of you may have met Ravi during last December's analyst briefing. Within a country operating model, we prefer to use local management since contact with local clients and customers is crucial. We expect that Ravi and his team will greatly contribute to our profitable growth strategy internationally.

When you hear from us again at our third quarter earnings announcement, we'll be only days away from the opening ceremony of the Athens Olympic Games. We have a long and proud heritage of service at the summer as well as the winter Olympic games, which started in 1968. The 2004 summer games in Athens will mark the 13th time we've had the honor to serve the world's best athletes, coaches, officials, as well as several other parties. Dozens of ARAMARK managers are hard at work as we speak preparing for the complex logistical process. We are confident that they show the world once again the best of ARAMARK.

With that, I will now open up the telephones for questions. Operator?

Thank you, sir. The question-and-answer session will begin at this time. [Caller instructions.]

Our first question comes from Brandt Sakakeeny with Deutsche Bank. Please state your question.

Thanks. Good morning. Bill and Joe, could you just give us a sense -- and also Fred -- given the investment that you've had in the capex numbers, and I think you've talked about both new contracts as well as improving the technology in your uniform businesses, when do you think we'd see the benefit of that in the higher margins? I mean is that something we'd see as soon as fourth quarter or we'd really have to wait till FY '05? And, also, can you give us a sense to the returns of those investments? Thanks.

This is Fred. Those investments are really part of the ongoing reinvestment in the business. In uniforms, for example, we are having some margin improvement. I wouldn't view that as really a finite project that begins and ends but really an ongoing program of upgrading our rental plans. And in the food business, most of it is associated with new contracts, where we make some investment in connection with new business.

The returns that we expect for acquisitions and for capital investment is we target a 15-percent after-tax internal rate of return on the investment.

Okay, great. Thank you.

Thank you. Our next question comes from Sharat Shroff with Morgan Stanley. Please state your question.

Hi. Good morning, guys.

Bill, you talked about the start-up costs in your prepared comments in the healthcare sector. I was wondering if you looked through the lifecycle of those contracts, when do they typically break even?

And at current levels today, what percentage of your new sales are coming from the healthcare sector?

I would say, you know, these are very long contracts, the majority of them being 10 years in length, and obviously, you know, we plan on keeping them for a lot longer than that. I would say that, you know, the start-up cost is probably a six- to nine-month hit, and after that, they're profitable. And, again, it's great business, and I would say that these contracts are rather complicated, and you know, I'd say that these start-up costs were a little bit more than we thought they'd be, but clearly, they're great clients, it's great relationships, and they'll be great clients for a long time and very profitable.

Can you care to quantify the impact on fiscal '04 numbers from these start-up costs?

This is Fred. We typically don’t talk about individual results on individual contracts. I think it's just safe to say that these -- there are a number -- as we've announced over the last three to four months, a number of contracts that we started up that are significant. I think we've talked about the revenue sizes in those announcements. There are a range of services, and they're fairly complicated to start up.

Okay, fair enough. And my last question, Fred, looking at the [X factor][ph] for you guys, it looks like 45 percent is [doable][ph] and that there's a different amount of medium-term debt as well. What is your strategy to possibly [indiscernible] and also to switch from floating to fixed rate? Is it just a question of closing out some of the existing swaps or [indiscernible] to new swaps? Or what is your strategy going forward?

Well, we've actually been increasing our percentage of debt that is fixed [inaudible] rate. And right now, we're at about 60 percent or so fixed, and that's up. Earlier in the year, we were around 50 percent, and we've done that through some debt-hedging transactions. And you have to also remember that our debt at this point of the year is pretty much at a peak and that debt comes down over the back half of the year seasonally, so we expect that our percentage of debt that is fixed will rise naturally as we move through the balance of the year. So we have taken some actions on that.

Okay, great. Thanks.

Thank you. Our next question comes from Michael Schneider with Robert W. Baird and Company. Please state your question.

Good morning, guys. I guess the question is mainly on the margins, and it seems just to be a frustration of mine that despite the stellar organic growth you guys are posting, we just aren't seeing it in the operating line in terms of rising operating margins. And I'm trying to gauge -- for example, in the first quarter, you listed the start-up expenses. You also listed the disadvantage of having one less week in the first quarter. I believe we actually have -- we caught that up this quarter in terms of timing, so that should've benefited margins, plus you had 7-percent organic growth.

Now, you know, you've talked exhaustibly about the start-up costs, but without some indication as to how big those were, I guess we're still left wondering why 7-percent organic growth isn't translating into operating margin leverage. And, Fred, maybe you can give us just some more color on the numbers and, in particular, why the calendar shift didn't benefit you this quarter.

Well, I think that the best way to look at it, Mike, is to look at the year-to-date results, which eliminates -- essentially eliminates this calendar shift impact. And the margins year to date in the food business are equal to the margins from last year, so that takes the calendar shift out. And, essentially, that is a combination of the positive margin pick-up from rising organic growth, although you have to recognize that that organic growth rise has been late in this six-month period, offset by some continuing pressures that we see in our labor-related costs -- worker's comp, state unemployment insurance, and the like. And, again, these -- when you start up new contracts, if you're adding revenues at pretty healthy rates and, in fact, those contracts are generating, you know, what are relatively small losses in the overall scheme of things, but it does have an impact on your margin improvement.

So last quarter, we were talking about accelerating margins throughout the balance of the year. Given the guidance, it seems like there's some small amount of accelerating margin year over year in the second half of the year. Is it fair to say, though, as we enter fiscal '05 we start to see the benefit of it given that unless we expect organic growth to go into the double digits, we should start to plateau in organic growth in the high single digits here and really start to see the ramp or the conversion of those new contracts and the profitability?

Yeah, this is Bill. That's a fair comment. I mean we do think that, you know, you will lap these start-up costs, and our hope is we'll have more big accounts like this next year. But as you have the start-up costs for those, the ones you had the year before will then be producing profit. So I think, as we've said before, we do expect, you know, 10 or 20 basis points' improvement in the margin. I think we'll see the same for '05.

Okay, then specifically in the uniform business, you had 3-percentage points' pick-up in organic growth sequentially. That's a big number for the uniform businesses, which don't change direction all that fast. Can you just discuss maybe each of the elements -- new business being up a point? It looks like pricing was maybe a half to a point better this quarter sequentially, and add stops being even better by a point? It looks like on this trajectory, you're headed to mid-single-digit organic growth pretty quickly.

Well, let me -- this is Bill again. There is still probably a small impact again of the calendar here in that, you know, even though we've backed out education, where we knew we could identify the fact that the two holidays in the month, you know, in the second quarter -- or actually in the first quarter versus one being in the second quarter last year, may make the growth look a little bit higher. But, clearly, we are seeing a turnaround. We're extremely happy to have 3-percent organic sales growth. You're right about the -- the shrinkage is going down it slightly. We still have shrinkage, but clearly, over the last 12 months, we've seen improvement there. So we're happy with it. The retention is where it's been. The new business sales are up a little. However, we do have, you know, costs for these added sales people we're putting on, as well as, as Fred said, you know, there was clearly pressure from worker's comp and healthcare expenses. And, you know, we've got people that are targeting that to see what we can do about it, but currently, it's a challenge.

Can you talk specifically about March and April as to what you saw in add stops or shrinkage because the minus-4-percent number is a trailing 12-month number. It's trending positive, I believe, which implies you may even be in positive territory in March and April?

We wouldn't normally, Michael, talk about individual months. I think that the best way to characterize it, it was flat in the first quarter; it was 3 percent in the second quarter. I think, as Bill pointed out, the timing of the New Year's holiday first quarter versus second quarter year to year clearly was a factor in the organic growth rate in the second quarter. So if you average the two out, you're saying about 1.5-percent, let's say, organic growth for the six-month period. And we have seen some improvement clearly in the organic growth rate from the first quarter to the second quarter but certainly not nearly as much as indicated by the zero versus the three.

If you look at the other elements of organic growth, one of the pick-ups in the second quarter was the fact that the sales force cranked out 13-percent sales versus 12. That's a nice improvement, but it's certainly not an improvement that we would expect to happen on a quarter-in and quarter-out basis.

And the last point, I guess, is on the add stops. The improvement that we are seeing there quarter to quarter rounds to 1 percent, but it's really less than 1 percent.

So I think the sales force productivity is solid. We're pretty comfortable with where that's going to be quarter to quarter. The retention is pretty constant. So from here going forward, I think a big part of it is just gradual improvement in the shrinkage.

But, Fred, I think we ought to make clear that the add-stop ratio is still negative.

Yeah, it's negative.

It's less negative, but it's still negative.

Right, right.

So we haven't seen that flatten -- not come to zero yet.

Okay, thanks again.

Thank you. Our next question comes from Adam Waldo with Lehman Brothers. Please state your question.

Good morning, gentlemen. It was nice to see the organic revenue growth get into the targeted 6-8-percent range for Mission One this quarter, a very good job.

Starting at a very high level, I wonder, Joe, if you could comment a little bit about how you all are positioning the company for the Athens Olympic Games in light of pretty high terrorist attack fears. Are you doing anything unusual from an insurance protection standpoint and from a management standpoint?

Well, we don't talk about specific things that we do with the company, Adam, but I think from a management point of view, we have an experienced team there. Many of the people there were at the Sydney Olympics before. We have a local partner that we've been working with. It's fair to say that our security people here have been very involved. We have some people on the ground there who are helping us, who are in touch with the U.S. government representatives over there. And we're working very hard to make sure that our part of the Games comes out very well, and I'm sure it will.

Okay, thank you for that.

Then sticking with the broader issues internationally, obviously a major French competitor has had some significant problems over the last year, which have accelerated in recent months, and I wonder if you can comment strategically how that is affecting your thinking, both with respect to potential new business-write intensity and also how you see that affecting the existing markets where you have a high degree of overlap, like the U.S. and France?

Well, I think it's fair to say that we are, you know, focused on what we can do in controlling our own destiny. Make no mistake about it; the markets continue to be extremely competitive with very worthwhile competitors in the marketplace, both here and overseas, and our teams are doing an outstanding job of capturing the opportunities that are available to us, both here and you've heard about the international activities that are doing quite well, as well as new markets, some of which I described to you. I think that situation's not going to change in the short term or intermediate term, and as you also know from our history, we don’t comment on the competitors.

Joe, would you say that any of the acceleration of organic revenue growth that you saw in the latest quarter would have been attributed to perhaps some of the instability at that competitor? Or would you just prefer to reserve comment?

Well, I think I would probably comment that the outstanding performance of our teams that have done extremely well, both in terms of growing, you know, base business, as well as capturing new business, all of which -- and as well as retention rates, all of which lead to organic growth. So one cannot look at one element. One has to look at the totality of the picture. And in some markets, we're doing better at base growth; some markets, we're doing better at new business.

Okay, and then finally for Fred, if we can just circle back to the question about capital structure a bit, positioning for a rising rate environment, from a surplus capital allocation standpoint, you continue to pursue both a deleveraging and a share repurchase strategy, and I wonder if you can comment on what investors ought to expect in terms of your thinking with respect to the mix of surplus capital allocation to both in a rising rate environment?

Well, I think, Adam, that we obviously start with making sure that we reinvest in the corporate-level capital expenditures in the business, and then second in the priorities is to make the right source of strategic acquisitions and add-on acquisitions to strengthen the business, and we've been fairly busy there internationally, in particular.

And then with respect to share repurchases, our view is that, you know, on average over time, we think it's worthwhile to return a portion of our excess cash flow to shareholders now in the form of a dividend but also more significantly in the form of share buybacks. And we can do all of that at fairly healthy levels and still improve our credit ratings because it is very important that we protect that credit rating. And we can essentially distribute pretty much all of our cash flow, either through acquisitions or through the dividend and the share repurchase, and still improve those ratings. So that's pretty much the policy that we have followed and I think we'll continue to follow.

So if I've read your body language, on a net basis, we would expect relatively limited deleveraging going forward, the use of the swaps market to try to manage interest rate risk and the mix in floating versus fixed as you talked about earlier and most surplus capital going to acquisition share buybacks and dividend hikes?

Yeah, I think we drive -- we really manage the debt more on a ratio basis, debt to EBITDA, interest coverage, and those sorts of metrics, as opposed to the absolute level of debt. And if the absolute level of debt stays the same, those metrics actually improve because obviously our cash [indiscernible] is improving.

Thank you very much.

Okay.

Thank you. Our next question comes from Bradley Safalow with JP Morgan. Please state your question.

Hi. Good morning. Good job on the quarter.

Thanks.

Just on the first question on the business and industry segment, you reference that you did see a sequential increase in the growth rate. Can you give us a sense for beyond the new business what sort of volume trends you're seeing at your existing clients? Have you seen any improvement there, or is it still consistent with what you saw in the prior quarter?

I think it's fair to say that we are seeing some positive signs with respect to the base business. Now, having said that, that organic growth rate in the second quarter, as Bill mentioned with respect to the uniform rental business, they clearly benefited somewhat. It's hard to quantify from the fact that the New Year's holiday fell in the first quarter. So I think that probably tends to overstate that number a bit, but I think it's also true that we have seen some improvement pretty much across the board in some of the base business.

Sure. And then my next question -- again, not to belabor this point on margins, but you've obviously had a very strong growth in healthcare, some significant new contracts. Some of that shows up in the food side, some shows up in the facilities. The facility portion, in terms of revenues, is it still around 45 percent in the healthcare segment?

Yeah, I think it's roughly [50][ph] percent.

Okay. So I guess going forward as we look, is this an issue with more so the mix of your business having shifted could impact the margins somewhat in the next several quarters until you anniversary where you're seeing stronger growth?

This is Bill. I don't think so. I think, you know, the margins are fine. Again, some of these start-ups cover both food and facilities, and it's, you know, hiring a lot of people and putting the team in place to get it going. But I don't think the margins will be negatively impacted, whether it be food business or facility business.

Okay, so the fact that, you know, you've had, again, strong growth in healthcare in the mix shift and where you're getting growth from versus, let's say, historically sports and entertainment or business and industry, has not impacted the margin profile of what you can achieve?

No, no, it's not a lower-margin business at all.

Okay, and then just a, I guess, a quick question on the acquisitions number for the quarter. I just want to make sure we have everything that's in that number. You had Catering Alliance, the increased investment in Chile, the Cleanroom platform in Canada. Is there anything else in that number?

I think that's right. In the first quarter, of course, we had the impact of Fine Host. It's not a factor in the second quarter. And then we had one or two very small uniform rental acquisitions, a million or two million, a few million dollars in sales --

Okay.

-- which we've adjusted our organic growth rate for, but they're de minimis.

Okay. That's it for me. Thanks a lot.

Thank you. Our next question comes from Kevin Monroe with Thomas Weisel Partners. Please state your question.

Looking at the midpoint of your guidance in terms of revenue for the rest of the year and what you did now, it kind of implies that fourth quarter revenue will be flat to down year over year. Is there any -- I realize the last fourth quarter you had a 53rd week and you're benefiting there, but is there any reason why that revenue would be down year over year?

As you mentioned, it's the 53rd week. If you think about it, it's really about 7 percent. It's one -- with a 14-week rather than a 13-week quarter. So in looking at the quarter itself, the 53rd week is significant in terms of the revenue it generates for the quarter.

Okay, and the Olympics and organic growth wouldn't be enough outside that?

No, well, the Olympics is -- we don't really recognize revenues from the Olympics. We operate there on a management fee basis, so we're not running revenues through our P&L. But I think it's fair to say that adjusted for the 53rd week that there isn't any big difference between the third and fourth quarter with respect to what we see in organic growth.

Okay. And do your organic growth expectations for the rest of the year, I mean is that -- what are you kind of basing that on in terms of the economy? You said earlier in your prepared remarks that, you know, it's too early to kind of call an improvement, I guess, in employment. Are you assuming that employment continues to rebound or is just kind of flat, or what are your bases for the organic growth assumptions?

We're assuming a gradual improvement.

Okay, thank you.

Thank you. Our next question comes from Chris Hussey with Goldman Sachs. Please state your question.

Good morning, gentlemen.

Morning.

Why don't we start with this question on the cash flow? Trying to get at the acquisitions you've made over the last year, I know one of the problems with acquisitions in your group is that you still have to amortize a lot of the acquisition cost contracts. On a cash basis, I suppose that wouldn't have an impact. I guess I’m a little surprised to see the cash flow only up 12 percent for the first half of the year given all the acquisitions you made last year. Are you getting the kind of cash flow out of those acquisitions that you anticipated, or is there anything that might not be delivering on that side?

No -- this is Fred. I think the cash flow that we're getting out of the acquisitions is fine and pretty much on pro forma.

Okay, so that 12 percent -- because I kind of look at that 12 percent as sort of being a -- you know, a pretty good indicator of what your business would be if you didn't have to do all the, you know, crazy amortization of contracts. So that 12 percent year-over-year growth is sort of a good run rate for what we should be expecting from you guys?

Well, if you look at the -- yeah, I think it's pretty -- if you look at our overall goals for EBIT growth, for EBITDA growth, they're all in that range. And if you look at the '04 versus '03, the big acquisition in '03 was Fine Host. Fine Host was in for three quarters of '03 and will be in for the full year '04. So the year-over-year impact of the Fine Host in terms of cash flow is -- '03 to '04 is not terribly significant.

Okay, great. The other thing you guys mentioned was that you were seeing an acceleration, it sounded like, in the last six months -- in the later part of this first six months in terms of your base business. I know this has been kind of asked before, but, you know, is it fair to say that the organic growth rate you're seeing of 7 percent in the second quarter, albeit impacted, you know, by various things that you maybe didn't back out, might have been 8 or 9 by the March/April timeframe?

No.

No.

No.

This is Bill again. I think if you take our year-to-date number of 5 percent and assume, you know, it's slightly better than that, maybe it's 6 percent for the second quarter if you could take everything out and make it perfect. But [you're actually][ph] correct; I'd go from the year-to-date number. And, again, we're hoping to see some improvement in employment, but there's nothing significant we've seen so far.

You mentioned, also, the lost business was up. Was it simply a matter that lost business was surprisingly low last year or --?

Yeah, this is Bill again. Absolutely. I mean we're still on target to come in at 95-percent retention, but, you know, this is still a very competitive market out there.

Last question. Fred, did that hedging -- is there any potential negative impact from rising rates with some of the hedges you've been doing?

No, no. Obviously, we have a certain amount of floating rate debt. That would be affected by rising rates. But the hedging actually has reduced our dependence on floating rates.

Very good. Thanks, guys.

Thank you. Our next question comes from Monica Aggarwal with Merrill Lynch. Please state your question.

Good morning. Off your new business [indiscernible], how much is coming from cross-selling opportunities? I think you said it was around 15 percent in the last quarter.

Yeah, I think it's 25 percent of the new business in the quarter came from Mission One. I think year to date, we're looking at a $95m number, and joint accounts where we did sell both food and facilities together, it was about 26 of that. [Cross side][ph] of business is bringing somebody else in; again, was a big piece of that.

Okay. And would it be fair to say that, you know, the marginal profit dollar that you make on these multi-service accounts or the cross-selling -- when you do cross-selling is better once you've cycled through the initial start-up costs?

No, I would say it's consistent with the rest of our business.

Okay. And then final question. On the uniform side, what's sort of leading to the better pricing environment? You know, you would think that it's a very, very competitive business, and yet you're getting about a 1.5-percent benefit from pricing in organic sales.

I think, Monica, with pricing being very tough over the last couple of years in price declines, you know, I would assume what's happening is the competitors in the market have been hurt by the price declines, and they're becoming more aggressive in pushing for appropriate price increases given that we have same energy cost increases, we've seen labor-related cost increases, worker's comp, and the like. And, you know, I think early in a recession, everybody competes for market share. You start to get [dinged] a little by that, and I think competitors typically then focus more on pricing than on margin. And, you know, it seems that that's what's going on here.

So it seems like the market's becoming more rational? And would the price increases reflect the cost increases?

Well, the -- yeah, in terms of the market becoming more rational, it's still a very price-competitive market.

Sure, yeah.

But having said that, if you look at our margin overall, we've been able so far this year to pretty well offset our cost increases --

Right.

-- through price increases and through producing, for example, our garment cost. As we continue to self-manufacture more of our garments, we are clearly seeing the benefit of that. So we'd have certain cost categories for actually reducing our cost as a partial offset, and pricing is another offset. Having said that, you know, we still face high energy costs and fuel costs and some labor-related costs. So it will continue to be a challenge.

Okay, thank you.

At this time, I'll turn the call back to Gary Sender for closing comments.

Thank you, everyone, for participating in this conference call. Obviously, a replay will be available shortly, and if anyone has any other questions, feel free to contact me. Have a great day.

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