Aramark (ARMK) 2004 Q3 法說會逐字稿

Good day, everyone. And welcome to the Aramark Corporation’s Third Quarter Fiscal 2004 Earnings conference call. Today’s call is being recorded.

At this time for opening remarks and introductions, I would like to turn the conference over to Mr. 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 third quarter fiscal 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.

I’d also like to introduce and welcome [Bobby Sheville] [ph] who has joined our team as our Associate Vice President of Investor Relations. Bobby and I will continue to provide support to all of you, and Bobby joins us from Merrill Lynch.

Joe, Bill, and Fred will present an overview of our third quarter results and business operations, after which there will be an opportunity for phone and 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 that are attached to this morning’s press release which can be found on our web site at www.aramark.com.

In the earnings press release and in today’s discussion of results we mentioned certain financial measures that are considered non-GAAP. Generally a non-GAAP financial measure is a numerical measure of the Company’s performance, financial position, or cash flows that either [decrease or increase] [ph] items different than those prepared or presented in accordance with generally accepted accounting principles. The Investor Relations Section of the Company’s web site includes the 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 [transition] [ph] of this audio may not be done without the prior written consent of Aramark.

Various remarks that we 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 the 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 Aramark submitted financial reports to the Securities & Exchange Commission.

We disclaim any duty to update or revise such forward-looking statements whether it is 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 for taking the time to join us. I’m pleased to discuss with you today our third quarter and year-to-date results which demonstrate continued execution of our Mission One strategy, and importantly, great momentum in organic growth rate.

I will cover our consolidated results and highlight a growth initiative that we announced earlier in the third quarter focused on our customers’ dining preferences. Fred Sutherland will discuss in detail the results of our individual business segments and other financial matters. And Joe Neubauer will wrap-up with a discussion of our recent acquisition in China.

Third quarter sales of $2.6b were up 11 percent over last year’s third quarter. Organic sales growth was 8 percent, including a solid 9 percent for U.S. Food and Support Services. We are pleased to see across-the-board organic growth in both economically sensitive and non-economically sensitive businesses for the third quarter, as evidenced by mid single-digit growth in business services and 3 percent sales growth in our Uniform Rental segment.

After adjusting for the net positive affect of two non-operating items in the 2003 third quarter, which Fred will describe later, income from continuing operations was up 7 percent to $64.5m, and earnings per share increased from 31 cents to 33 cents on the same adjusted basis. Growth over the prior year quarter was somewhat constrained by the shift of our fiscal calendar.

While we experienced margin improvements in many of our businesses we are disappointed that we weren’t able to increase our overall operating income margin in the quarter, and Fred will expand on this issue during his discussion. I can, however, tell you that this is a high priority for our entire Management Team. We are reevaluating our business processes, including our cost structure in those specific businesses, and are focusing on costs that are within our control.

For the first nine months of 2004 sales were up 10 percent over prior year to $7.6b. Overall, organic sales growth of 6 percent, comprises 7 percent organic growth for Worldwide Food and Support Services, and 2 percent for our two Uniform Services segments.

Year-to-date income from continuing operations increased 14 percent to $178.5m, excluding the two non-operating items for the third quarter of last year. And diluted earnings per share increased 16 percent to 92 cents.

For the first nine months of the year internal cash flow of $218m was up 10 percent from the prior year. As a reminder, we define this metric as income from continuing operations, excluding the previously mentioned non-operating items, plus non-cash charges such as depreciation, amortization, and deferred taxes, less net capital expenditures.

New business sales were up over the prior year, but lost business year-to-date was also higher than the prior year. A significant portion of the reduction was due to business we decided not to renew because the new contract terms would not have met our financial objectives. Although we continue to operate in very competitive markets we have required and will require acceptable economic returns on all of our contracts.

Mission One continues to make good progress. Year-to-date Mission One sales as a percent of total new sales were more than 25 percent. Just a year ago Mission One sales as a percent of our total new sales were only 10 percent, quite an improvement. And that’s because our teams continue to collaborate both geographically and on an account-by-account basis to drive new and base business growth.

We have spent a substantial amount of time describing our Mission One initiatives, including how we’ve organized the sales and marketing teams, performed client assessments, realigned our incentive systems, and we’ve drilled down on some specific cross-selling and multiple service wins.

A very important aspect of Mission One is how we respond to customer needs. Doing this well should help our base business growth at each client location. As many of you know, earlier in the third quarter we publicly announced our new dining styles and Just For You programs. I wanted to take this opportunity to expand on this introduction and give you some history on our process.

As part of our business development, Aramark monitors the preferences and eating habits of the customers we serve every day. While customers consistently requested more nutritional information over the last several years, many showed little interest in actually eating healthier items when they were offered. In early 2003 we noticed the shift in this behavior. And quickly responded with new offerings to address the move to healthier eating. To best serve our customers we believe it’s important to understand their needs and behavior rather than just copy fads in the marketplace. As a result we conducted a thorough analysis of data on the away from home consumer eating habits, and found that although healthy dining is not for everyone, all customer sites are looking for meal options that fit their dining styles.

The research identified six distinct dining profiles of our customer base. Ultimately, this analysis resulted in the development of our dining styles program. Once the profiles were identified we respond with innovative, customer driven offerings like Just For You, which features hundreds of new, healthy menu items with easier to understand nutrition information and bold menu identifiers to make it easier for diners to find the foods that are right for them. Importantly, Just For You is highly flexible, and will be quickly updated as new customer needs and dietary trends emerge.

We have implemented Just For You at selected campus healthcare and business dining pilot locations throughout the country, and expect to expand the program this Fall. The program has been well received by clients, and early indications show that customer satisfaction levels have improved. Having mailed captured data from over 150,000 customers at 700 Aramark campus and business dining locations our dining style research program has become the food service industry’s largest and most sophisticated source of insight on the away from home nutritional preferences and eating habits of consumers.

We believe that Just For You will be key to maintaining high client retention rates, growing our base business, as well as winning new clients. Our dedication to clients is a driving force behind the development of programs like Just For You. It speaks to our commitment to our clients as a solution is provided.

Now I’d like to turn the call over to Fred Sutherland, who will discuss our financial results by business segment.

Thanks, Bill.

As Bill said, for the third quarter consolidated sales growth was 11 percent, and adjusted income from continuing operations growth was 7 percent. As we discussed last year in the third quarter of fiscal 2003 Aramark prepaid a portion of its outstanding debt, resulting in an extinguishment charge net of tax of $4.7m. The Company also reached the settlement of certain open tax years and reduced the provision for income taxes by approximately $8.4m. The net affect of these two items added 2 cents per share to the 2003 third quarter EPS.

We’re particularly pleased with the improved organic sales growth that we saw in the third quarter. Our economically sensitive businesses are starting to show some improvement. Our Worldwide Food & Support Services third quarter organic growth was 8 percent, 9 percent in the U.S., and 5 percent internationally. As a reminder, our Education sector had one less service week in the third quarter of 2004, compared to the prior year. And the approximate one percentage point impact of this is included in the organic growth calculations.

Part of the high single-digit organic sales growth in the third quarter was due to strong performance of our baseball operations. Uniform Rental organic sales growth was 3 percent, and direct marketing organic growth of 4 percent was consistent with our second quarter results.

Third quarter sales for the U.S. Food & Support Services segment were $1.8m, an 8 percent increase over the prior year’s quarter. Organic sales growth was 9 percent. Year-to-date sales of $5.1b are up 8 percent over the prior year, and 7 percent organically. Again, the year-to-date organic calculation also adjusts for one less service week in our Education sector.

Sales growth in Business Services was in the mid single-digits in the third quarter. The strength and sales growth was driven both by net new business and some base business improvement, aided by new marketing and merchandising initiatives. We are seeing early signs of an improvement in business conditions. Though we have not seen significant headcount increases at our client locations, our clients and customers have increased their spending. As Bill mentioned, we are in the midst of the rollout of the Just For You program. Although the cost of the rollout has had a somewhat negative impact on profitability it is well timed and is being enthusiastically received by both our clients and our customers. New business services accounts signed during the quarter include Quest Diagnostics, the Associated Press, and OfficeMax.

Reported sales were about flat in the Education sector due to one less service week. We have seen strong new business in our K through 12 market. Some specific new accounts include the [Levitt Town School District] [ph] and the Wilkes County School District in North Carolina, as well as the University of Southern Mississippi.

The Sports & Entertainment sales were up low double-digits for the quarter, driven by year-over-year attendance at our major league baseball accounts, and strength in our convention center business. We expect this growth rate to moderate somewhat in our fiscal fourth quarter due to fewer scheduled major league baseball games in our parks, and a more modest summer concert season compared to a strong concert performance in the fourth quarter of 2003. We are pleased to announce the cross-selling win to provide stadium services to Florida State University. We have also added the Paramount Theatre in Denver as a new client.

We are in the midst of our National Park season, and expect performance to improve slightly year-over-year. However, we have reduced our first fourth quarter estimates for this business. While attendance at many of our locations is up, we are still facing challenges in some of our Western National Parks due in part to the ongoing drought situation. This has received prominent press coverage over the past several months, and has resulted in higher cancellation rates and lower late Summer bookings.

The [field] [ph] sales growth was robust in the quarter, increasing in the low double-digits. New wins combined with expansion of services for accounts such as Evanston Northwestern Hospital drove this continued strong sales growth. New business includes Milliken University in Illinois, McCormick Place, Carolina’s Healthcare System, and the [Christa Santa Rosa Healthcare] [ph].

Healthcare and Corrections, which make-up the other sector, delivered high single-digit growth. The terrific performance in these businesses came mostly from base business growth with some new business, as well. Recent new account wins include providing food along with the facility services at Christa Santa Rosa Healthcare, and we signed our first correctional food services agreement with the Texas Department of Criminal Justice.

Third quarter operating income in the U.S. Food & Support Services segment was $89.5m, up 4 percent over the prior year. The year-over-year profit increase was reduced by about 3 percentage points due to the forward shift in our fiscal calendar which caused this year's third quarter to have one less service week in our Education sector.

The operating income margin was 5.1 percent versus 5.3 percent in the third quarter of 2003. Solid margin improvement in our Domestic Food business was more than offset by the impact of the one less week in our Education sector, a year-over-year margin decline in our facilities business due to losses from recent multi-services contracts, and by lower profits in our clinical equipment business. We continue to expect that these contracts will achieve more normal levels of profitability over the next year but we will still be in an investment mode during the fourth quarter.

Turning now to the International Food & Support Services segment, third quarter sales were $475m, a 31 percent increase over the prior year, with foreign exchange contributing 9 percentage points to the increase. Organic sales growth was 5 percent and included a balance of new and base business growth. We experienced particularly strong growth in Canada, Belgium, and Spain. We recently began to consolidate the sales of our Chilean Joint Venture now that our ownership is 51 percent. These sales were excluded in our calculations of organic growth. Recent new wins include the Olympic Stadium in Berlin, the [Los Antonios Hospital] [ph] in Germany, and [Hospital la Macarana] [ph] in Spain.

Third quarter operating income for the segment was up 17 percent over last year to 19m. Foreign exchange contributed 8 percentage points to this growth. Belgium, Canada, and Spain experienced strong earnings growth, however, lost business and higher operating expenses in the U.K., and the initial consolidation of our Chilean joint venture constrained margins in the third quarter.

Now let’s turn to our Uniform and Career Apparel segments, starting with the rental segment. Third quarter sales were $262m, a 3 percent increase over last year’s third quarter. Organic growth was also 3 percent. New business sold continued at a solid rate of about 13 percent of the year earlier base, with about 60 percent of the new sales coming from first time users of rental programs. Lost business was about 8 percent. Price increases contributed 1 percent of the third quarter sales growth, while base business declined 3 percent due to continued contraction at existing accounts.

Third quarter operating income was $29.1m, up 1 percent over last year. Improved productivity from investments made in the business and lower merchandising costs due to our increasingly efficient offshore sourcing operations were more than offset by higher vehicle fuels, sales force ramp-up costs, and labor related expenses. It contributed to a 30 basis point decline in the operating margin. We expect these cost pressures to continue into the next quarter although we believe the fourth quarter margin comparison should be more favorable than the third quarter.

Third quarter sales for the direct marketing segment increased 4 percent to $105m. Organic growth was also 4 percent. Operating income in the segment declined to $2.5m due to increased marketing and administrative expenses, coupled with the gross margin reduction in our public safety business, driven by the mix of product sales.

Turning now to total company financial metrics, interest expense was $31m, decreased $9.9m from the prior year quarter, which included the $7.7m debt extinguishment charge. Lower borrowing levels and lower rates in 2004 also contributed to the interest expense reductions. At quarter end total debt was about $1.9b.

In anticipation of rising interest rates, over the past 12 months we have taken actions so that roughly 70 percent of our debt portfolio is now at fixed rates. We’ve recently established the new five-year $150m pound European revolving credit facility that will be used to fund investments in our European business. The facility allows for multi-currency borrowings and provides additional funding capacity in Europe.

Net capital expenditures, which includes all capital expenditures less normal disposals totaled $200m for the first 9 months of the year, compared to $174m in the prior period. Internal cash flow, a metric which we define as income from continuing operations plus depreciation, amortization, and deferred taxes, less net capital expenditures was $218m, an increase of 10 percent over the prior year.

In the third quarter we repurchased 1.44m shares of our common stock for about $40m. Approximately $100m of our current authorization remains.

Now I would like to update you on our outlook for the fourth quarter and full year of 2004 results. As a reminder, our fourth quarter of fiscal 2003 results of 54 cents per share included insurance proceeds related to our operations at the World Trade Center, as well as a loss associated with the disposal of a residual interest in our magazine and book operations. Adjusted for these items last year’s fourth quarter EPS was 47 cents. In addition, 2003 was a 53-week year and the financial impact of that extra week was entirely in last year’s fourth fiscal quarter. We estimate that the extra week increased our fourth quarter 2003 diluted earnings per share by roughly 7 to 8 percent.

Our fourth quarter 2004 earnings will be affected by several factors. As I mentioned earlier, we are feeling the affects of contract startup costs and other cost pressures, particularly in our Healthcare business. As I mentioned earlier, we have also reduced our expectations for the Parks business.

Finally, the recent Federal Government investigation concerning export sales at Gall’s has had an adverse impact on our Uniform direct marketing segment. While Gall’s actual export sales are less than 5 percent of its total sales, the uncertainty surrounding the investigation has very recently started to affect the direct marketing segment. We now expect fourth quarter operating income for our direct marketing segment to be well below prior years.

We expect to report sales of between $2.5b and $2.6b for the fourth quarter and diluted earnings per share in the range of 46 cents to 48 cents. This fourth quarter estimate implies four-year sales of between $10.1b and $10.2b, and diluted earnings per share of $1.38 to $1.40 which is consistent with our original estimate for fiscal year 2004 of $1.38 to $1.44 per share, and implies a 52-week EPS growth rate in the low to mid teens in line with our longer term earnings per share targets.

Now I’d like to turn the call over to Joe Neubauer to wrap-up.

Thank you, Fred.

I continue to be impressed with the way our Management is executing our business model, and retaining and winning business in a very competitive marketplace. More than 25 percent of our new business is coming from Mission One activities, and that effort while still early on was launched just 18 months ago. We’re moving this big ship in the right direction, and I am confident that our business model is quite valid.

Our current organic growth, sales growth, is within our long-term range target of 6 to 8 percent, and we are internally focusing on improving our short-term operational issues in order to deliver our desired longer term results.

As many of you know, our strategy for our International business is to grow organically as well as pursue acquisitions and joint ventures, particularly in new markets. Last week we announced our entrance into China by acquiring 90 percent stake in [Brite China Services Industries] [ph], or BCSI, a leader in the growing Chinese facility services market. BCSI has been an Aramark ServiceMaster management services franchise since 1998.

We think that BCSI provides facilities services including plant operations and maintenance, central transportation services, security, grounds maintenance, and housekeeping to about a hundred clients in Beijing, Shanghai, [Guandong] [ph], and elsewhere throughout Mainland China. It has recently also begun offering dining services.

We are very excited about BCSI as it not only allows us to build-out our facilities business, but it provides the infrastructure platform necessary to grow our dining services. For example, BCSI recently signed food service contracts with Sony Corporation, and [Sosho] [ph] and [Funan] [ph] Hospital. I would like to welcome BCSI’s clients, customers, and 6,000 employees to Aramark.

While this is a modest start, I am excited by the growth opportunities that we see in China. Aramark would benefit as the country continues to build out its infrastructure, create domain for leading edge services, and moves towards specialization and privatization. For example, the Central Chinese Government is strongly urging Government owned hospitals to outsource at least one department to the private sector. And there may be additional opportunities for Aramark as Beijing is preparing to host the Olympic Games, Summer Olympic Games in 2008.

Which brings me to the current Olympic Games, which as you know will start this Friday. I’ll look forward to joining our Aramark Team tomorrow in Athens as we demonstrate the Gold Medal service that Aramark is known for. We’re very proud of our achievements and the achievements of our Team, as they have started our operations, and we’re very confident about what they will accomplish during the Games.

A Herculean effort in the Greek City seems quite appropriate. And it’s because, just like the athletes, years of training and experience at 12 other Olympic Games has allowed us to provide unmatched world class service. We can’t wait for the official opening of the Olympic Games.

And now, I’d like to open the phones to questions, Operator.

[Caller instructions.] ]

Our first question today will come from [Monica Agarwalt] [ph] with Merrill Lynch.

Good morning. The startup costs that you’re discussing in healthcare and the labor related expenses were also mentioned in the last quarter. So are these sort of trending ahead? Are the costs higher than what you initially anticipated?

This is Bill. You know, new contracts typically achieve the expected profitability in the first 12 to 18 months. As we’ve said before, these are very large comprehensive accounts. Were they the way we want them, and not having started up accounts of this size we underestimated the cost and complexity to open them. We think we’ll still incur some startup costs in the fourth quarter, but by 2005 these accounts should be performing to the level we expected. Remember, these are 10-year agreements with quality institutions that we’re very proud to serve.

Okay. And then in terms of the downgrade in the fiscal 4Q numbers, can you sort of discuss them by problem areas? What is the biggest area? Is it the Park, or is it the Uniform side?

This is Fred. As we mentioned in the prepared remarks, there are a couple of factors. As Bill mentioned, first, we continued to see the negative profit impact of the new accounts that we started up. And while we’re confident that those will still hit our overall targets over the long-term it’s taken a little bit longer, I think it’s fair to say, to get those where we want to.

The Parks is clearly a factor in the fourth quarter. As you know, the Parks big profit quarter is the fourth quarter, and to a lesser extent the third quarter. So the fact that we have had weaker bookings and some higher cancellations because of the publicity on the drought, it clearly is a factor in the fourth quarter. And then the third really is Gall’s. And I really wouldn’t attribute any of those as being meaningfully more significant, or less significant than the other.

I mean where are you in the Federal investigation process right now? And how long could this take?

This is Bill, again. You know, the Department of Commerce investigation involves the possible failure to obtain export licenses or prepare accurate shipping declarations in connection with certain exports of Gall’s products. You know, Gall’s is fully cooperating in the investigation and reviewing its export procedures. Obviously, we can’t predict the outcome of the investigation, but as we have mentioned Gall’s export sales are less than 5 percent of its total sales. And the vast majority of these export sales do not require a license. This investigation just happened, and we’re being somewhat cautious with our expectations.

Okay. Just one final question then. What is the growth, organic growth ex the Education [inaudible]. I think it may have been impacted by 1 percent, so it would be 10?

That’s right. In fact, we’ve got I think a web schedule.

Okay. Great. Thank you.

With Lehman Brothers, Adam Waldo has our next question.

Good morning, everyone. Following up on the Gall’s investigation, just want to try to quantify this a little more precisely, if I may. Your Uniform direct marketing business, roughly 4 percent of run rate revenue, and Bill, I believe you said that only about 5 percent of Gall’s revenue is export sales. So are we talking about, you know, something on the order of .1 or .2 percent of revenue business for Aramark that’s affected by this investigation?

You know, it’s 5 percent of Gall’s revenue, but the stuff that we’re looking at is strictly the stuff that requires a license. And as I said, that is most of the export sales do not require a license. So it is a very insignificant amount of sales. The question is what other people, you know, feel nervous about the fact that you have an investigation.

Fair enough. Turning to some of your cost structure issues, Fred, I wonder if you could just remind us what percentage of Aramark’s total revenue is comprised by aggregate energy costs? And what percentage of your cost structure is affected by food products that you purchase on the spot market?

Okay, Adam. The energy cost in our Food Support Services business, energy costs are not a significant portion of the business. In many cases, in almost all cases we’re operating on the client’s site, and in many cases we’re not actually paying the utility costs or the energy costs, and our Food Support Services business is not principally dependent on vehicles or routes, only our vending portion which is relatively small.

And the Uniform business, our total energy costs, and this would include both fuel costs for the route vehicles principally as well as energy costs to run our plants which is mostly natural gas, runs between 3.5 to 4 percent of our Uniform Rental sales. So it’s a meaningful cost for the Uniform Rental segment, but it’s not a meaningful cost for the remainder of our businesses.

Fred, would it be fair to say that energy costs in the aggregate are less than 1 percent of total Aramark revenue?

Yeah, I think that’s fair to say that.

And then on the spot market purchase food product inputs?

Well, I’m not real clear on what you mean by spot market?

I’m sorry. By that I mean what percentage of the food products that go into the contract food business are subject to short-term price fluctuations as opposed to being governed by the Cisco contract or related hedging activities?

This is Joe. Let me try for a minute, Adam. Our prices are – Cisco, as you know, is a logistics company. We buy our product directly from the manufacturers. Some on long-term contracts, some in short-term contracts. But one can assume that as prices fluctuate over a period of time, you know, that they’ll eventually work their way into our cost structure overall. But we have a lot of ways and means to moderate those by menu changes and by product substitutions. So I would not say that product cost is a significant element of our cost structure.

Fair enough. So would it be fair to say then that the growth in EBIT margin comparison year-over-year were not materially affected in the quarter by either energy costs, inflation, or food cost price fluctuations but much more so, as Bill said, by the startup costs of these new contracts?

This is Bill. That’s fair. Obviously, if you just looked at the Uniforms, clearly, when you pay the price you’re paying for gasoline it’s significant to them. But for the overall Company, that’s fair.

And then, finally, for Fred, any update on guidance for full year tax rate?

Our tax rate, overall tax rate runs about 37.5 percent. And we would expect it to be in the 37, 37.5 rate for the overall year.

Thanks very much.

Uh-hum.

Our next question comes from Brandt Sakakeeny with Deutsche Bank.

Thanks. Good morning. Just wanted to follow-up on Adam’s question, I guess a little bit with respect to the startup costs, more. Bill, what confidence do you have that you all have effectively figured out the appropriate IRRs given the higher startup costs? Is that a function, one of timing, or more additional investment required than you had originally expected? And therefore, does that run the risk of having lower IRRs in that business than you had previously forecast?

Yeah, this is Bill. No, I don’t think that’s going to happen at all. I think it’s a learning experience, quite frankly. You know, we’ve sold two major accounts since this, and we’ve signed them on a fee basis for the first year. These are very, very complex organizations, where we’re taking on all of their people, and basically all of their services. And quite frankly, it was new to us, and we missed it, we think we understand it now. And we think going forward we’re going to limit that happening again.

Okay. And Fred, with respect to the share repurchase I think you said 40m in the last quarter. Can you update us in terms of, you know, with the stock where it is today what levels are, I guess, just more broadly used for cash flow going forward? Thanks.

Yeah, we generally don’t comment on future share repurchase plans, but we do have $100m remaining under the current authorization. And as you can see, our pattern over the past 8 quarters or so we’ve been generally a regular purchaser for the fund.

Okay. I guess finally, sorry, for Joe or for Fred, a question on sort of the organic growth rate. The 8 percent was obviously a good number, particularly in light of where the economy was, and some of the issues in the Uniform business with the negative same store sales numbers. You know, I know you all have generally said 8 to 10 is your target growth rate. Should we expect that perhaps in ’05 we could see growth rates in the double-digits given the ramp-up of the startups associated with these big new contracts? And assuming a cyclical improvement in the Uniform business?

I think our targeted overall growth rate in the top line is really more in the 6 to 8 percent range, overall. And as you point out we did see organic growth domestically that was in excess of that range. As we mentioned, prior to that was the fact that we had very strong results in major league baseball. And you might remember that the third quarter of last year, the weather wasn’t too good, and there were some rainouts and that sort of thing. So we really haven’t changed our overall organic growth targets, it’s the 6 to 8 percent top line.

Okay. Thank you.

With Morgan Stanley, we will now from [Chris Boutek] [ph].

Thanks. Good morning, guys. I look at the operating margins across the four reportable segments, they were all down year-over-year, and all were down more than we had, or down lower than our expectations, as well. Is there any broad deterioration in the business that you guys see potentially, for example, pricing pressure picking up a bit so you’re not able to cover your costs? Or conversely, maybe the cost structure getting away from you guys to some extent? And any big picture theme of that that you see emerging?

This is Bill. No, I don’t. You know, Fred did mention on the Uniforms side for the third quarter, and also mentioned that we do expect a more normalized margin in the fourth quarter. I don’t think it’s anything that’s permanent. I think the fact of the matter is we think our model works, you know, 6 to 8 percent top line, and we’ll leverage it. I think we’ve got some operating issues that we’ve talked about and highlighted. And I think it’s just a matter of time to get them behind us.

And I think Bill, you talked about in your prepared comments some contracts you did walk away from from a pricing perspective. Clearly, there are costs, recurring costs that are rising, healthcare, workers comp, et cetera. Could you elaborate on what you are seeing from a pricing perspective in terms of how willing the customers are to accept the price increases to help you cover your cost increases?

Yeah, obviously, not every customer wants to jump up and say ‘I want to express the price increase.’ Clearly, we have mechanisms to raise prices. We definitely have had, you know, labor increases. It’s something, again, we monitor. It’s something we pass on when we can, but I think, again, Chris, the model is working and I think, you know, we’ll just get these things behind us.

Okay. And then finally and separately, looking at the Olympics, I mean they’ll be starting in a few days, and everything that we’ve seen suggested attendance could be somewhat below expectation. Do you guys see any risks that given the fixed cost inherent in your operations there that with potentially light attendance that could cause less earnings and that could be an additional source of disappointment in the fiscal fourth quarter?

Chris, this is Joe. As you know, we have been engaged in the Olympic Games for a long time. We try not to take any risks on attendance or [inaudible], or anything at all with those, at Olympics. And therefore, we don’t think there’s any risk there.

All right, thanks.

At all.

Let me go back to something that Bill answered a couple of moments ago. We don’t think there’s anything wrong with the model. I think it’s a question of timing or recovering any cost structure, whether it’s inherent in our business, whether it’s labor related costs or other costs, sometimes there’s a lag, sometimes it takes us a little longer to execute on it, but the basic fundamental of the business in terms of how we price the business, the kind of cost structures we have, you know, the fee versus P&L mentality of the business, the competitive nature of the business has not changed.

Okay, thank you.

We will now hear from Chris Hussey with Goldman Sacks.

Hi, good morning. It’s actually John Shapiro sitting in for Chris. On the, wanted to just touch a little bit on the top line pickup in the U.S. You were talking about, you know, again about how organic growth obviously came in strong. But you haven’t in business services, you haven’t really seen increases in headcount yet. You know, where is the base business growth coming from if it’s not people?

This is Bill. I think we’re seeing base business growth because I think people feel better about the economy. We’ve clearly seen a lot of our customers lighten up the purse strings as far as catering and other things. And there is some employment coming back, but again, it’s not significant. But that and I think some of our new food plans are doing just a great job.

On Mission One, you know, that continues to do, I guess, even better than we would have thought, you know, over 25 percent of new business. Is there something, though, when that really started to accelerate that’s when I think the margin started to, you haven’t been getting sort of the consistent 10 to 20 percent, 10 to 20 basis points that you, you know, sort of talked about over time. Is there something structural in the cost base? Have you – are you spending more money now on average in the selling process across the organization? Are there more meetings, is there more travel? You know, are there teams that you’ve now put in that that just is, you know, that’s a cost that’s not going to go away?

This is Bill. My answer to that would be no. Again, it’s, you know, some of these major hospitals, again, do cross all the different lines. But it’s actually the complexity of those. It would have nothing to do with the Mission One sales coming in at lower margins. We still price every service the way it is, and there’s no wholesale discount if we do more than one.

Okay. And then just lastly, well, I guess, two. One on the Gall’s, is what you’re seeing is this U.S. customers that are in some way avoiding doing business with you? Or are they sort of holding? I mean can you just sort of elaborate on, you know, what you’re seeing?

Yeah, I guess the problem with doing that is this thing has just happened, and it’s you know, clearly something that has some impact. I mean, you know, we monitor the sales every week. We don’t think it’s something that’s going to be dramatic. And, you know, we’re just working hard to try and get this thing behind us.

But the slowdown you’re seeing, or that you’re potentially going to see at Gall’s, that’s not, given how small this export business is, it’s not associated with that business? It’s – you’re worried about a potential backlash from U.S. customers?

Actually, you know, there might be some. Again, it’s too soon to really say. I mean I’m looking at the sales every week, and I can look at last week’s sales, and it’s not like we’re down 40 or 50 percent.

Okay. And then just lastly on the [NHL] [ph], you know, can you just sort of quantify how big that business is for you? You know, what it could look like if let’s say there were no season for an entire year, what that might cost you?

This is Fred. The NHL sales, we don’t expect it to have any impact on the fourth quarter, or fourth fiscal quarter. And the overall NHL sales for a full year are less than one percent of our total sales. So if they were a strike for the full year we clearly would have the profit impact of those sales, but that would be net of mitigating, you know, cost reductions that we would do.

Okay. Thanks very much.

With Credit Suisse First Boston, [Smitha Rogmalarney] [ph] has our next question.

Hey, this is Smitha Rogmalarney and Josh Rosen. I was wondering if you could talk a little bit more specifically about your ad spots and the Uniform Rental market for the entire quarter, as well as month by month?

Well, we don’t comment on ad spots month by month, but the ad spots for the quarter were negative 3 percent. And that was an improvement of about 1 percent from the prior quarter. It had been running around 4 for the prior, I think for the prior couple of quarters. And it was a little bit better than that in the third quarter.

Okay. Thank you. And also, with your international food acquisitions, what’s generally the revenue multiple been for these acquisitions?

Well, this is Joe. I think it’s very difficult to generalize on either multiples, on revenue, or multiples on EBITDA, or multiples on EBIT. I mean each situation is different. Clearly, China that we just talked about is a very modest acquisition for us, but it’s really a strategic acquisition to gain a window in China. And clearly, in small acquisitions sometimes you become a little more aggressive than you are in some larger acquisitions. And so it’s difficult to generalize, but I think it’s fair to say that we would look to every acquisition to be shareholder enhancing and accretive in a fairly reasonable period of time.

Great. Thank you very much.

We will now hear from Brad Safalow with JP Morgan.

Hi, good morning. I was wondering, going back to some comments Bill made earlier, if you could elaborate on exactly what you’re looking at within your cost structure? And how quickly you think you can implement changes to improve margins?

Well, I don’t know how much detail I can get into. Clearly, I’ve mentioned the major healthcare accounts that we’re looking at. Also, we’re looking at some structure in our clinical technology services business. But I can’t really get into much more detail than that. I mean it’s good business, it really in some ways separates us from the competition. And again, I don’t think there’s anything that we can’t handle. It’s just a matter of, again, some big accounts and some other things that we missed.

So aside from, you know, the trends and the investment you need to make in these newer accounts, I mean are there things that you feel you can do within your other business units that can get operating margins back in the right direction in the 3 to 6 month timeframe? Or is it, should we expect something a little longer than that?

Well, it’s hard to be that precise. I mean we can, you know, I can tell you on these major accounts as I said, I think in ’05 they will be hitting the targets that we set for them when we signed them. There really isn’t a heck of a lot more invested in any of this than our normal businesses. This is an investment. This is an investment in people, and in learning the process of running these big accounts. And a new business to us, you know, CPS. So I think we’ll get there. To tell you what quarter it’s going to happen in, we’re not that precise.

We also have initiatives underway with respect to the broader costs, such as workers compensation and healthcare. And we’re making a number of changes as a result of those efforts, with respect to both those categories of costs across our businesses.

Sure. And then just on the food side, can you give us the current mix of profit and loss contracts versus management contracts?

It really hasn’t changed at all, I would say from what it has been.

Okay. So 60, 40 is still kind of the general mix?

Right.

Okay. And then just the last question for Fred on the, in your comments about the Education Division I think you said including the calendar shift it was flat year-over-year? Is that right? Organically, in terms of growth?

No, what we said was that the reported sales for our Education sector were flat, and the reason that they were flat year-over-year was because of the calendar shift.

Sure. So looking at the detail in the press release it’s about $24m impact. Can you give us what the organic growth rate was ex that? And then I can guess based on what we had as an estimate as to the size of that Division, but just want to see if you can give us some more detail?

Well, I mean generally we don’t calculate organic growth rate at that level, but generally, the Education business has been performing pretty stable from quarter to quarter.

Okay. Thank you very much.

Michael Schneider with Robert W Baird has our next question.

Good morning, guys. Just to beat this startup issue a little more, could you quantify what you believe the incremental unexpected expenses were in the third and fourth quarters?

I think as a matter of policy we don’t comment on the profitability of individual accounts.

Okay. Well, then cut another way, how much revenue have you recognized from these contracts? And is that really the problem, that the contract implementation is behind schedule and you’re incurring the costs but not recognizing the revenue?

This is Joe Neubauer. I don’t think it’s either one of those. I think we’re recognizing revenue. I think we’re incurring the costs. We’re incurring larger costs than what we expected. And let me just elaborate a tad on this. When we entered these relationships we clearly had to assume a cost structure for the existing institutions. And that becomes the basis of what we then propose to them. As these comprehensive contracts are fairly new to us and to them, the granularity and the preciseness of that cost structure becomes a challenge, as we go into it, up front. And that’s really has been the challenge for us.

As we got into it and we reviewed what our assumptions were, it became clear that we didn’t have all of the cost structure, and neither did they. It’s nobody fault, just something new that everybody is doing. Once we get on top of that then we go back and re-discuss that with the institution, and arrive at a different economic arrangement with them, and it will just take a little time to get on top of all of that. That’s really what’s going on here. It’s not recognizing costs, not recognizing revenue, that’s really what’s going on here.

Okay. And then the guidance. You’ve trimmed this quarter back to where you originally started, and I’m wondering in raising the guidance last quarter is there anything else that we haven’t talked about in this call aside from National Parks and the startup costs, et cetera, that didn’t transpire, that you had assumed would, and led you to raise the guidance last quarter and trim it this quarter?

I think the – this is Fred – I think the issues are really as we stated. I think the new accounts have taken us a little longer than we assumed three months ago, and in the last three months we’ve had weakness in the Parks business as a result of the negative publicity, that’s really occurred in the last three months. And then the Gall’s issue.

Okay. And then I’m curious, too, is part of the margin challenge related to the increase in lost business rates? You mentioned you’re walking away from business. Are these some of the more profitable accounts? And we’re seeing the loss of those accounts flow through the margins?

This is Bill. No, that’s absolutely not true. Actually, the business we told you that we’re walking away from, we haven’t actually lost the revenue or the profit yet, it’ll happen next year.

Okay. And then two final questions. First, we’ve heard from a number of companies, industrial and otherwise, that it’s a summer slowdown, there’s obviously a debate going on here as to whether there really is one. Can you give us your general feel for the momentum of your business as you went through the summer? Did you experience a slowdown?

This is Bill. At this point I haven’t seen a slowdown. Again, our economically sensitive business we mentioned are up. So we think that’s a good sign.

Up for the quarter, but did you experience any deceleration through the quarter?

No.

Okay. And then, finally, I’m told by a couple of contacts that you’ve taken some efforts to maybe eliminate or trim some of the middle managers at the Food Service accounts to maybe expand the span of control of some of these district and regional managers. First, is that indeed occurring, and is this a reaction to some of the margin challenges that we’ve been talking about?

This is Bill, no. I haven’t seen any major change because of the, you know, where we are today. I think we’re, as I said, I think we’re at a good place. I think, obviously, with the environment out there, labor costs and other things, you know, there are some issues we’re dealing with. But I don’t think any organizational change we’re doing has anything to do with the margins.

Okay. Thank you.

[Jakiv Alam] [ph] with [Hygiels Capital] [ph] has our next question.

Hi. It’s actually John Jacobson. A couple of questions, about the capital structure and philosophy. And first of all, do you guys think that $1.9b is sort of the right level as the business is presently constituted, you know, going forward?

This is Fred. The, we typically run the capital structure between a two-to-one and a three-to-one debt to EBITDA ratio. At $1.9b we’re at the low end of that range. We’re down towards the two-to-one. We were up at the higher end of the range just immediately after the ServiceMaster and the Services acquisition, when we – which was an $800m acquisition. But I think it’s – and we have an investment grade rating. I think it’s fair to say that we’re very comfortable where we are, and in fact, we’d be comfortable at a ratio higher than where we are.

Okay. All right. And so, you know, so the follow-up question to that as you sort of look at roughly, you know, the four levers that are available for you to sort of re-deploy your, you know, three hundredish odd million of free cash flow, and you basically have, you can pay-down debt, you can make acquisitions, you can buyback stock, and you can give it – you know, start organic projects. I mean how do you think about over time sort of what the appropriate sort of mix is, you know, for those four different opportunity sets?

Well, we start with the premise that we want to maintain an investment grade debt rating. And we think if we’re between that two-to-one and three-to-one ratio, although, you know, obviously, the rating agencies look at other things, that that’s the first and foremost priority. The depreciation and amortization typically covers net capital expenditures within plus or minus $10m or $20m. And then the remaining free cash flow typically would go to appropriate acquisitions to expand and strengthen the business, and particularly, to expand our network internationally. That typically doesn’t absorb all the free cash flow on average, year in and year out, the philosophy pretty much is that the remainder is distributed back to the shareholders, a portion in the form of a dividend, but really the majority from a dollar point of view in the form of share buybacks.

Right. And how much of those levers change based upon sort of, you know, where the stock price is, you know, how you asses the risk of acquisitions? You know, are your [inaudible] rates or IRRs per organic projects versus acquisitions, and I mean just how you, just trying to get a sense of how you sort of think about it? Is that adequate?

Well, we start with capital expenditures, and we look for 15 percent IRR in our investments back into the business associated with new contracts and expansions of the business. And we will, that’s really the first priority. We look for the similar return on the acquisitions. We can control that to some extent by participating or not participating. We don’t control the timing, and if we don’t control whether we actually make an acquisition or not, if it’s a competitive situation.

Right.

So that’s hard to predict. And then again, our view is that the remainder on average just goes back to the shareholders.

Right. Thank you.

With Omega Advisers, [Chris George] [ph] has our next question.

Thanks. I guess most of them have been covered, but I did jump off for a second so I want to make sure I’ve got it right. I think you mentioned 42m in stock repurchases in the quarter, or 40m, that looks like it’s 42, if you back into the numbers. Did you mention an average price you paid?

Yeah, I think it was – I didn’t, actually. But I think it was about $27.

Okay.

I have it here somewhere. Yeah, $27, $27.70, somewhere in there.

And you said you have $100m remaining under your current authorization?

That’s right.

If you chose to accelerate repurchase because you felt that the stock price looked relatively low, could you or would you hypothetically buy more stock than you generate in cash during the quarter, say in the fourth quarter?

This is Joe Neubauer, Chris. I think we have to remember that we only run the Company, you know, for growth. We run the Company, you know, for profitability. And we run the Company for the benefit of all of our shareholders long-term. You know, we don’t control the price of the stock on a long-term basis. And we think that the model, as I said before, continues to work, you know, extremely well.

I think we probably have a tendency to buy on a more moderate even keel level of the stock. Clearly, if the stock is a little lower we might accelerate a little bit, or we may accelerate if it gets a little higher. But I don’t think that, you know, we are out there, you know, buying stock based upon we think it’s too cheap or too dear.

And Chris, to answer your other question about the sort of cash flow for the quarter. We don’t really look at cash flow available for the quarter. You know, we look at the cash flow that we generate over the period of a year, or two years. We’ve got plenty of financial capacity in the form of, you know, unused credit, and the Company generates strong cash flow. So when we look at it on a quarterly basis we’re really not looking at the cash flow for that quarter as a factor.

Right. When you look at the balance sheet, you know, it appears that you’ve been able to run the business with basically no networking capital. Is there anything different in the new business you’re generating that would suggest that the cash flow characteristics of that business may be any different than the rest of the business?

No. No, not at all.

Okay. So you continue to expect that your free cash flow either roughly equals or exceeds your EPS?

Yeah.

I mean assuming no acquisitions? Which obviously are not in your guidance.

Yeah, we still see roughly net capital and depreciation amortization and deferred taxes being roughly in alignment, and working capital sources and uses being within shouting distance of zero.

Thank you.

Why don’t we take one more question.

Thank you. The last question for today’s session will come from [Scott Hill] [ph] with [Brown Brothers] [ph].

Good morning, guys.

Good morning.

Good morning.

I guess looking at Mission One, I think at least one characterization would be that it’s having terrific top line success, and may be surprising at least a lot of people on the outside. But a fair characterization might also be that it’s at least in the near-term disappointing in terms of margin potential. And I think there’s lot of questions on this, but I think Joe’s last comments were a little bit helpful but maybe we could get a little further delineation there.

How much of your cost activity is really driving around changing the economic terms now that you’ve uncovered costs that either you or your customer didn’t anticipate? And how much is actually, okay, we have just actually got to take costs out? In terms of those two buckets, if you can define them as such, you know, what percentage of your activity is really renegotiating terms versus actually drilling down on your cost savings activities?

This is Bill. You know, clearly, you know, the labor related costs generally have been up. And I think it’s not, you know, I don’t want to confuse anyone that it’s just a startup of a number of accounts. Clearly, you know, we know what the issues are, we’ve isolated them, there are a few places, and we’re going to get them behind us. The Mission One new business is not coming in at a lower rate than other businesses. And, you know, we’ve got plenty of accounts where we had one service, we pick-up a second service. So it shouldn’t be confused that Mission One has anything to do with lowering margins.

Again, you know, Mission One are using the same resources that you’d be using if you were selling a new account, but it’s taken an account where you have a relationship, getting more business there. Again, it’s growing the base business there, which we’re clearly showing we’re doing. So I would not confuse Mission One with the issues. One has nothing to do with the other.

Bill, you were clearly, I mean the startup costs on the near-term margins have got to be lower than what you’ve anticipated long-term economics on that business?

Yeah, that’s fair.

Okay. So my question is is that now given that you have an acceleration of costs or through your, or heavy costs in the up front portion of the contract, in trying to tackle those what percentage of those costs are actually ones that require renegotiations on the economic terms to Joe’s point, because they were just unanticipated by either you or your customer you’re serving? And how much of that overall up front cost is actually one that you can get behind by substantial cost reduction efforts, not renegotiating contract terms?

Yeah, I think in looking at those two pieces the majority of the margin improvement on those accounts comes from getting the costs in alignment. And it’s not taking costs out below where we assumed we would take costs out, or it’s really executing on moving from day one, we have a cost structure which is the client cost structure, because I’ve inherited that. Say X, we have our cost structure. So we move methodically from their cost structure to our cost structure. And it’s really the efforts, most of the activity is around that effort.

Now it’s also fair to say that as a part of that we will discover let’s say that some information we got from the client wasn’t exactly right, or there were costs in the system that the client didn’t tell us about, or maybe the client didn’t even know about, if it’s an allocated charge of some kind, where we have to go back to the client and say we made, we took this over, this business over as based on information that you gave us and some of that information is wrong, and therefore, we have to rebalance between you and us. I wouldn’t say that that’s the majority of it, but it is a portion of it. But it’s clearly not the majority.

Okay. Then just one thing in terms of capital use, you guys have talked at length here and are very helpful about what’s your normalized capital use options and strategies are, but I think you guys would move opportunistically if you guys had a terrific acquisition. And would allocate a larger portion of your available cash to a deal or transaction that you found opportunistic present itself. I’m just a little surprised that when you look at share buybacks that you wouldn’t also look opportunistically, as well. That given, you know, what must be to you guys obviously substantial decline in stock price, which is disappointing, wouldn’t opportunistically move in and actually take today’s opportunity represented to yourself in the same way you would an acquisition?

Well, I think that we are as disappointed as you are in the price of the stock, and we’re working hard to, you know, improve the fundamentals, to improve the price of the stock. I think we clearly cannot comment on any possible future acquisitions, nor can we comment on any opportunistic opportunities to jump on the stock at this particular point in time.

I think we will consider looking at it as we’ve looked at it in the past. And try and get and even as I said, lower rates, at lower prices, we might accelerate it a tad, at higher pricing we might decelerate it a tad. And we have plenty of the spreads, we have plenty of authorization left, and we have plenty of capacity left.

That’s great. Congratulations on a very substantial top line performance.

Thank you.

Thank you.

Mr. Sender, I will now turn the conference back to you for any closing or additional comments.

Thank you all for participating in the conference call. The Investor Relations Team will be here to answer any other questions you may have. So everyone, have a great day.

Thank you. A rebroadcast of this conference is available starting today at 1:00 p.m. EST, and will run until August 18th, 2004 at midnight EST. You may access the rebroadcast by calling 888-203-1112, or 719-457-0820. Please reference pass code 267309. Again, those numbers are 888-203-1112, or 719-457-0820, with the pass code of 267309.

Thank you, everyone, that does conclude today’s conference. You may now disconnect your lines.

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