信達思 (CTAS) 2002 Q4 法說會逐字稿

Please stand by.

Good day everyone and welcome to the Cintas fourth quarter 2002 earnings release.

Just as a reminder, today's call is being recorded.

At this time, I would like to turn the call over to Mr. Bill Gale, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

Good morning and welcome to our fourth quarter conference call.

We are pleased to announce that Cintas achieved its' 33nd consecutive year of growth in revenues and income despite, a difficult economic environment.

Results for the 4th quarter were also a record for sales and net income.

In the fourth quarter, our rental business grew at a rate in excess of 9%, while other service revenues, which consist primarily of direct sale items increased by 1%.

This resulted in total revenue growth in excess of 7%.

Net income also grew 7% in the quarter to a record $64.1 million dollars or 37 cents per diluted share.

Cintas continues to remain highly profitable, achieving improved rental margins and comparable net margins similar to last year, and well within our targeted range.

Margins for other service revenue declined slightly, due in large part to the sluggish environment for the purchase of uniforms, clean room supplies and catalog items.

SG&A showed an increase as a percent of sales, due to the conscious effort to aggressively invest in sales and marketing initiatives. Our current guidance of revenues and earnings per share for the fiscal year ending May 31, 2003 calls for total revenues of $2.8 billion to $2.9 billion, and diluted earnings per share of $1.55 to $1.62.

This guidance assumes an improving economy as we move through our fiscal year.

With the weaker quarters being the quarters ending August 31 and November 30, 2002.

Included in this guidance, is approximately $300 million in revenue and 3-4 cents per share in earnings from Omni/RUS with most of the efforts in fiscal year '03 being spent on consolidation of facilities, and thus profit improvement. Omni is expected to contribute most of its positive impact in the second half of our fiscal year.

The guidance provided above for the year indicates total revenue growth of 21% to 26% despite one less work day in fiscal year '03, than we had in fiscal year '02. Internal growth represents about a 9-12% growth with the balance coming from acquired growth.

Each year in the coming year, excuse me, each quarter in the coming year will have the same number of work days. That is 65.

With me today is Karen Carnahan, Cintas' Vice President and Treasurer.

After some brief comments from Karen, we will open the call to questions.

The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor from civil litigation from forward-looking statements.

This conference call contains forward-looking statements that reflect the Company's current views as to future events and financial performance.

These forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those we may discuss.

I refer you to the discussion on these points contained in our most recently-filed Form 10-k.

I would now like to turn the call over to Karen.

Good morning, everybody.

I would now like to take you through our income statement, cash flow statement and balance sheet in a little more detail. We've updated our website with our fourth quarter financial results.

You may want to go to that section of our website and have the financial statements in front of you as I explain those numbers. When you pull up the fourth quarter news release, the first few pages will be the announcement itself, and the last the three pages will be the income statement, cash flow and the balance sheet.

Now I will first start by commenting on the income statement. Total revenues were $604 million for the quarter, a 7% increase over that recorded in the prior year. During the fourth quarter, the sluggish economy continued to have a negative impact on our top line growth. Many of our existing uniform rental customers continued to reduce employment levels.

We have seen some pick up in the sale of uniforms to our customers who buy their uniforms.

For the last three quarters, we have commented on the fact that these customers had delayed the purchases of new uniforms until they had a clearer picture on the direction of their business. Although we would not say this is a clear trend in the uniform sales side of our business, we are starting to see more activity in this side of our business.

Our customers are asking us to submit more proposals and we are quoting on more national account sales business than what we did in the third quarter.

Let me address the two segments of our business farther.

Rental revenues were $462 million compared to $422 million last year. This was an increase of 9.5%.

Our internal growth rate excluding acquisitions, was about 4% and the remainder was from acquisitions.

Acquisitions contributed nicely to the top line growth, about 5 percentage points.

Even though we had made a few tuck-in type acquisitions, over the past year, the largest acquisition contributing to this 5 percentage points of growth was Omni Services.

We acquired Omni on May 13. And that acquisition brought approximately $17 million of revenue to us from May 13 through May 31.

As I said earlier, without acquisitions, our organic growth was about 4% for the quarter.

We can break down our organic growth for our rental business further as follows. First, our business with existing customers continued to be under pressure due to the declining employment levels at our customer accounts.

We talk about this in terms of an adds-stops statistic. Which is a measurement of a change in billings when a customer hires a person and when they lay off or terminate a person.

We also quantify the amount of add ons and stop orders for our other rental products including our entrance mats, our shop towels, mops and hygiene supplies.

This adds-stops statistic continued it's negative course during the fourth quarter, but has shown signs of stabilizing in recent weeks.

Price increases have declined compared to last year, but they are still fairly healthy and ended up contributing about a percent and a half to our growth rate.

Our price increases are dictated by contract terms that specify that we can raise prices each year by either the consumer price index or 5%.

Raising prices by the CPI is actually automatic on the anniversary date of the contract. But each of our general managers has the latitude to go as high as 5% if they see a need to recoup some higher cost of serving the customer.

However, as the economy slowed this past year, so did our ability to raise prices.

The last key measurement of sales relative to existing customers is lost business.

Our lost business has historically run around 5-6% of our weekly volume.

As we mentioned in our third quarter call, our lost business had stabilized at a level slightly above 7% and it did in fact stay at that level for the quarter.

On a much brighter note, we continued to have tremendous success in writing new business and adding new customers for our rental services.

For the year, our total new business increased approximately 17% over the new business written in the prior year.

We also saw improved productivity in our sales force in the later half of the year to the point where the productivity per sales person reached an all time high in the fourth quarter.

With this continued success in adding new customers, our growth strategy has not changed.

We will continue to add to the sales force and capture this growth in new business and continue to increase our market share.

We will continue to backfill the entire sales organization. Making them more productive in writing new business. And we will continue to aggressively rule out marketing and advertising programs.

So before we move on, let me recap what we see in our rental business in total.

First, we are getting a healthy increase in new business, across all of our product lines.

This includes our uniform programs, as well as our ancillary services, such as entrance mats and hygiene products.

Price increases came in at a percent and-a-half level for the year.

We continued to experience shrinkage in our existing rental business during the fourth quarter. But this appears to have stabilized just in the last few weeks. And lost business stabilized around the 7% level and that metric appears to have improved slightly just in the past few weeks as well. Now addressing the Omni Services acquisition and how that is going.

Omni brought to us approximately $300 million in annual revenue. This business is predominately rental business and is a good fit with our business.

Omni brings to us 80 facilities. And there is tremendous overlap with our Cintas locations. We have already merged 12 of those locations.

Our plan is to merge approximately 40 operations all together.

In addition to that, the synergies of combining our two organizations will be fully realized once we have Omni on our computer systems.

The reason why the computer conversion is so critical, is because all of our sales systems, inventory, ordering, and control and service systems are tied together with our computer systems.

We intended to convert all of Omni's computer systems to ours by December 31st.

In other words, it will take us approximately seven months from the date of the acquisition to be integrated. This seven month time frame is about one half the time that it took us to convert the Unitog acquisition. That was a sizeable acquisition we made back in 1999. All other aspects of the Omni integration are going extremely well.

We plan to have all other corporate functions consolidated into our Cincinnati headquarters by January 31st. With the majority occurring by the end of this summer.

We are also renewing contracts with the previous Omni customers and we are pleased with the business and progress we are making in converting them to Cintas customers.

Now let me move on to discuss our other services revenue.

Other services revenue increased a half percent over last year.

This segment of our business includes the sale of uniforms, as well as the sale and delivery of first aid products and services and the sale of disposal clean room supplies.

Uniform sales for the quarter were up approximately 1% compared to the fourth quarter of last year. This is a significant improvement compared to the prior two quarters when our sales were down from the previous year.

Even though we did have some revenue contribution, this quarter from Angelica, for the most part our improvement resulted from the stabilization of in this side of our business.

The uniform sales side of our business was dramatically impacted by the tragedy of September 11th. Our customers had delayed their purchase decisions until they had a clear indication on the direction of their businesses. As I mentioned before, our customers are showing signs of upgrading their uniform program and we see opportunity to continue to increase the uniform sales side of our business.

The first aid and safety business and the clean room sales, also held up relatively well as they have throughout the year.

Now let me address the margins. Our rental margins for the quarter were 45.9%, representing a 60 basis point improvement over last years margin.

These improved margins primarily result from improved productivity in our rental facilities.

Our other service revenue margins of 30.7% compared to 31.5% last year. An 80 basis point decline from last year, but substantially better than the 29% margin we earned in the third quarter.

We had approximately $21 million of additional revenue in this quarter versus the third quarter .

And this allowed us to leverage the fixed cost of our distribution centers and show nice gross margin improvement on a sequential basis over the third quarter.

Our selling and administrative expenses were 25.3% of revenue and a 100 basis point increase from last year, primarily due to an increase in sales people, sales promotion and advertising.

Again, as long as we continue to experience success in writing new business, we will continue to aggressively grow our sales force.

Our net interest costs were 2/10 of one percent of revenue. Compared to the previous years 4/10 of one percent. Our average interest rate for our outstanding debt is approximately 4.5%, including the recent financing for the Omni acquisition.

Our effective tax rate was 36.8% for the quarter, and 37% for the year. The reduction of 60 basis points from fiscal '01's effective tax rate was due to the restructuring of our organization along state lines at the beginning of this fiscal year.

For the quarter, net income was $64 million compared to $60 million in last year's fourth quarter, with earnings per share up 6% to 37 cents per share.

Our after tax margins were strong at 10.6% of revenue and in line with last year.

Looking briefly at the cash flow statements, there are a few items of note. Cash flow from operations increased 53%.

This healthy increase resulted from working down our inventory levels by $37 million, managing our accounts receivable more tightly during this economic slowdown, and increase in our accounts payable balances in order to improve cash flow.

Capital expenditures for the quarter were approximately $22 million. And total CAPEX for the year was $107 million. Approximately 30% below last year.

We have cut back our spending wherever possible, without sacrificing customer service or our ability to add top line growth.

To address the balance sheet. The balance sheet does reflect the sizable acquisition of Omni, and the purchase price allocation that impacted every line item on the balance sheet.

However, carving out that allocation, we would make the following observations.

Accounts receivable is in good shape with DSO's around 39 days for the quarter.

Inventory levels, as we expected, decreased sequentially again from the third quarter by approximately $12 million. Our current ratio stands at 2.7 to 1 with cash and marketable securities of $85 million and a debt to cap level of 33%.

Our net debt to cap is approximately 30%.

In summary our Company is very strong financially. We have a well-orchestrated plan for integrating the Omni acquisition. And we are very please with the quality of the customers and the people that joined the Cintas organization.

And we are looking forward to making fiscal 2003 our 34th consecutive year of uninterrupted growth in sales and profits.

And now we would like to open the call to answer your questions.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please press the star key followed by the digit one on your touchtone telephone. We will take as many questions as time permits. And we'll take the questions in the order that we receive them.

Again, if you would like to ask a question today, please press star one.

We will pause to assemble the roster.

Our first question is from Michael Snyder with Robert W. Baird.

Good morning.

Congratulations on a nice quarter.

Maybe first we can start with Omni and talk about the sales force.

One of the disappointments, I guess, in the Unitog acquisition was the turnover or the intentional paring or pruning you guys did with the sales force at Unitog.

Can you talk about the similar issues in Omni and how many sales force people there are now, how many you anticipate keeping, et cetera?

Michael, I won't talk about the size of the force, but I will tell you that we have interviewed every one of the sales people at Omni.

Some of the sales people chose not to join Cintas, others did not meet our criteria.

And we're estimating that we will end up keeping about 40 to 50% of the sales force.

And can you give us a sense of what the minimum expectations were for the Omni sales force in terms of weekly revenue?

You don't have to us specific numbers, but maybe in percentage terms, how much higher your goal is versus the Unitog goal was, I'm sorry, the Omni goal was?

Well, our productivity was about twice the average Omni productivity.

When we evaluated a salesperson though, we didn't necessarily just look at that. We have a lot of criteria that we use to evaluate whether a salesperson can be successful in our business, and we applied that criteria coupled with their performance at Omni.

So basically, we treated each person, you know, in looking in terms of their future success with our Company, but also looked at what they had done on a past performance basis.

OK. And then in terms of the revenue expectations, it seems like you've trimmed somewhat the revenue expectation due probably due to some intentional pruning of the accounts down to $300 million.

Is that where you expect the revenue to settle out, or is it possible, like Unitog, that the ultimate book of business is even smaller than $300 million?

I expected to settle out about $300 million.

There's a couple of differences then with Unitog. One of the differences is that Omni has very little direct sale business.

Whereas Unitog had a fairly sizable piece of direct sale business. So that's one difference.

Another difference is that if you can recall, Unitog had some linen business, which is business we don't necessarily keep when we do an acquisition.

And we sold off some of the Unitog business. They also had sold off some of it prior to the merger.

So, I think you have a different set of circumstances here.

When we took over Omni, on May 13th, their run rate of revenue was approximately this $300 million. And so our objective during the first 12 months will be just as we did with Unitog, is to integrate that revenue into our systems. We will be shutting down some of their operations and merging it into ours, shutting some of our operations down and merging our volume with theirs. We will basically focus more on profit improvement of that business as we go throughout the year.

But I would expect at this time that we will retain about the $300 million.

OK. The final question on Omni. You said you included $17 million of revenue for the quarter. When I backed out a normal revenue run rate, it seemed to me, your internal growth rate would have been 6% or better for the rental business. So it looks like Omni had a, at $17 million, had kind of an out sized two or three-week period.

In fact, if you annualize that, you come out to about $370 million.

No, you don't.

No, Michael you come out to about $295 million.

And is that just because of days per week rather than actual work days versus--.

You have to use work days and if you calculate it, it comes out to be about $295 million.

Okay.

And then final question just on the sales force growth. What percent did the Cintas sales force grow during fiscal 2002?

We don't disclose that percentage. It disclosed though, it increased in an amount sufficient for us to generate a record amount of new business.

OK. That's what I was driving at. So the record sales force growth is what produced the record customer growth during the year as well?

We had record productivity also.

Thank you. Our next question will come from Greg Capelli with C S First Boston.

Hi Bill and Karen, It's Greg and Clayton.

Morning. Quick question on the adds-stop operation that you mentioned. Did that actually get worse over the previous quarter? And then any comments on the progression of it through the quarter?

No, it actually stayed at about the same pace as the third quarter.

I didn't see any significance between the first of the quarter and the end of the quarter. Except to say that it did appear to slightly improve once we got into the last couple weeks of May, the first couple weeks of June.

OK. I understand.

And then Karen, did you mention Angelica, I heard you mention on the other services about revenue growth line? Was that, you know, 2 or 3 percentage points?

No.

Angelica actually contributed approximately $4-5 million for the quarter.

What's tough about commenting on the Angelica acquisition is, it's direct sale business.

It is not something that is an annuity stream of revenue that you can predict how much it's going contribute in any one quarter.

And the other thing is, is that some of the Angelica customer accounts were also accounts that Cintas services. We in essence had shared those accounts together.

It's kind of difficult to objectively say when a revenue comes in for a specific customer, is it revenue that we would have generated by serving that customer that we had, or was it really brought in through the Angelica acquisition.

So, roughly $4-5 million for the quarter is our estimate of what is brought in.

OK. Got it. And I just want one final question on the pricing that you brought up at about 1.5% it sounds like. Is that, you know, generally from tougher competition and then, you know, is that kind of staying at 1.5% in your guidance going forward for '03 that you're gave out?

Yeah, that's roughly what we're expecting for next year and it is obviously impacted by the competitive climate and it's impacted by the economic climate.

I mean, company's willingness to absorb price increases is not as great this year as it was last year.

So, but we think that 1.5% is doable next year and also, Greg, that is consistent with price increase levels that we've had in the past.

Great. Thanks a lot.

Thank you. Our next question will come from Chris Gutek with Morgan Stanley.

Thanks. Good morning, Karen and Bill.

I want to ask a couple of questions about the expected synergies for Omni if I could. Would it be possible to break out your expected savings from closing the corporate headquarters relative to closing the operating facilities?

Chris, I'm really not prepared to get into that level of detail publicly with regard to the Omni integration.

As I stated in my remarks though, we expect there to be about a 3-4 cent accretion resulting from Omni during the course of the year.

I can tell you that we are going to completely shut down their corporate operations and we will get rid of all that function by January 31st.

Most of it's happening sooner than that.

But I'm really not prepared to break it out.

Okay. I guess there several areas where savings can come from.

One is certainly disposing of redundant facilities. But in addition, I think if we were to look at the gross margin at Omni, seeing about 500 basis points lower than Cintas historically, presumably there were some operating differences as well. With the trucks, [INAUDIBLE], the rental uniforms being expensed, maybe planned productive was lower, maybe garment costs were higher.

Putting aside the physical integration cost and maybe talking more qualitatively than quantitively. Could you talk a little bit about why their gross margin was so much lower and what are some of the operating things besides just closing facilities that you can do to bring those margins up?

Well, yes, I can talk about some of that. First off, we have some systems in place.

And when I say systems, I mean processes et cetera that are state of the art I think, for our industry.

That is why we've always achieved better margins than most of the competition. So we will apply some of those with the Omni business.

Our productivity among our route force tends to be much higher than most of our competition. We are able to utilize our size to obtain lower prices from our vendors on such things as hangers and chemicals and maintenance supplies.

As you know, we manufacture a large part of our product line.

Omni had no manufacturing at all.

So we will be able to ultimately take our product line and integrate it into Omni locations and achieve savings there.

I think the fact that we were able to not only eliminate their corporate headquarters but much of their regional management is going to result in improvement.

So when you add all those things together, that's why we say that it's going to be certainly accretive to us.

At the nominal amount here in the first year, but then at a greater amount as we go forward.

And one more follow-up on Omni if I could. And that is regarding the purchase price allocation. The accrued liability was increased, I guess this was filed in the AK a couple of months ago by about $28 million to cover required severance cost and some facility closure cost.

Could you talk about the expected timing of the cash payments relative to those severance payments and facility closure costs?

Yes, most of that, I would say all of that is going to be incurred in the first nine months after the acquisition.

The majority of it will happen.

The bulk of it is taking place at the corporate standpoint this summer and most of the operation integration will take place by December 31st as we convert over to these new computer systems.

OK. Great.

One quick question about the operating business if I could.

I think on an annual basis you do measure the percent of incremental revenues from customers coming from no programmers as opposed to the programmer market.

Have you tabulated that for the year fiscal '02?

Yes, Chris. It came in around 55% of our new business for fiscal '02 came from no programmers and the remainder from competition.

Many of you know that historically going back the last 10 years, our no programmer business has contributed roughly two thirds of our new business.

So this 55% statistic is down compared to what we've experienced historically.

And that is, we would attribute that to the sluggishness in the economy, the fact that many of our smaller competitors are struggling.

And it has been more effective for some of our sales force to go after that business that is currently served in our industry.

Okay. Great. Thank you, Karen and Bill.

Thank you. Again. if you would like to ask a question today, please press star one.

And we will now go to Amanda Tepper with JP Morgan.

Hi. Good morning, Karen and Bill.

Let's see, a couple of questions.

For your assumption for next year within the range you've given, you said you're, on a full year basis looking for 9-12% organic revenue growth on the rental side.

And you know, by my estimations to get there, I'm showing that you, especially on the high end, you'd really have to be at the 13-15%, and, if not more by the third and fourth fiscal quarter.

I'm wondering, you know, what you're looking at, especially on the employment side. Since that's a key driver on your, what I call same store sales, what you look at as add-stop.

I mean, that's going to have to turn pretty positive isn't it?

Well, first off, Amanda, let me correct you. The rental growth rates are, in total not just with rental.

Okay.

So 9-12% organic growth is for everything? OK.

We expect there to be, I would say, a stabilization in the add-stop ratio here in the first quarter, and then an improving situation as we go throughout the year.

We expect our lost business probably to stay at rates comparable to where it was in the fourth quarter and then improve throughout year.

So, it is going, we see the economy, you know, certainly picking up and impacting our business more so in our last two quarters than in the first two quarters.

Therefore, the growth is going to look much better in the latter two quarters, especially when you compare that those are the weak quarters in fiscal year '02. We do not go through an exercise of saying what we expect the unemployment rate to be or what the employment rate's going to be and then back into our numbers.

Our whole basis for the way we manage the Company is, we look at all of our components of growth, and our biggest component is new business.

And we certainly staff our sales force and develop our marketing programs and advertising programs to accomplish the objective of achieving certain levels of new business.

And then we basically have to be driven on our add-stops, and to a certain extent, on our loss business, by what just happens in the general economy.

Right.

Well, do you feel comfortable that you've got enough of your foot on the gas pedal, in terms of the size and productivity of your sales force that you can ramp up to meet this guidance even if the add-stop gets, you know, doesn't come back as much as you like.

No, I can't say that.

I can say that I've ramped up, we have developed a workforce and a strategy, I mean a sales force, and the strategy to achieve a very aggressive new business objective that we're very confident of.

Okay.

I cannot control necessarily what's happening with the add-stop ratio because that's a macro event.

Now, would I want to accelerate my new business even greater if my add-stops are worse?

I don't think I can turn that around that quickly because a new sales person that I hire, it takes them probably nine months to a year to become fully productive.

Okay. Thanks. That's helpful.

And then not to beat the dead horse on Omni, but, you know, again, your revenue guidance was a bit less than I'd assume.

Because you know, you say it was at a $300 million annual run rate on the day you closed it, and it seems to me a reasonable assumption to think that that run rate would improve under the first twelve months of ownership as you retrain the sales people, et cetera.

So I'm wondering why you're just taking that run rate and not thinking it would get more productive.

Well, Amanda, one thing we're taking into consideration is the fact that this computer conversion has to take place before we can start ramping up the revenue of any acquired company. We can't sell our product line and our service systems until they're fully integrated onto our computer systems.

Also integrated and so it's really impossible to go out and sell, let's take for example our Comfort Pant. An Omni location doesn't even have access to be able to order that pant effectively until they're converted to our computer system.

That's why we are adding that assumption in there.

Is because we know that that computer conversion's not completely done until the end of December.

Which would still give you six months though, wouldn't it, to be at a better than the run rate you bought?

Well, we'll give it partial, it will give us definitely, a partial year to be able to do what you are saying.

There's no doubt about that.

But in the meantime, we're just trying to factor in some reality and to -- here's another reason.

You go out and you're just now getting acquainted with these new customers.

The last thing you really want to do in your first couple of discussions with them is say we'd like for you to start buying more product.

The first thing they have to do is get comfortable with Cintas and our service, and our product line and then you ask for the additional business.

So we kind of view it as, you've got a period of time to prove yourself, to get them on our computer systems and then you start adding more growth.

And that's exactly the way we approached it with the Unitog acquisition.

OK. And then, you know, kind of a nit picky question on the interest expense for next year. You know, your debt levels were a little bit less than what I had forecast at year end.

But we've got it in terms of the way it's going to run through your P & L, very lumpy, because most of your interest expense is going to be the bond payment. Right?

Which is semi-annually.

So, first of all, is that a fair assumption that it's mostly your fiscal, I think it's second and fourth quarters?

We book the expense, though, ratably over the quarters.

Oh, you do?

Okay.

And each quarter has 65 work days, as Bill said, so there's the same number of work days in all four quarters for next fiscal year.

Okay. On a run rate, we had like $36 million of interest expense for fiscal '03.

Is that in the ballpark?

Boy. Roughly -- I don't have that in front of me.

I'd say it's probably closer to $38 million.

Okay.

Thanks. Just one last question because you mentioned the work day.

The one work day difference, right?

Well, that's in comparison to fiscal '02. So for example, the first fiscal quarter of '03 we'll have one less day than '02.

Then go to Q3, we'll have one extra day.

Then in Q4 we'll have one less day again.

So over all for the year, we'll one less work day than fiscal '02, but for the four quarters within '03, they have the same number of work days.

What's a day worth in terms of anything you could quantify on the P & L?

On a quarterly basis, if you look, it's about 1.4% of growth.

Of growth.

Okay.

Hey, Amanda, one other thing that just came to mind is that, going back to this Omni business, keep in mind, that the Omni historical lost business rate was higher than Cintas as most companies are or all companies are, I think, other than us.

Therefore, it takes us a while to kind of get that cleaned out of their system too.

That makes sense. That makes sense.

OK. Thank you very much.

Thank you.

Our next question will come from David Reidel with Solomon Smith Barney.

Yes, good morning.

A couple of questions.

First of all, can you talk a little bit about where you are in your facilities build out and roll out of automation into the facilities. And secondly, you commented a couple of times about your productivity for salesperson being at record levels.

To what do you attribute that? Any particular initiatives that you have on the street?

When you say talking about our plants, I guess, in build out level, we continue to add facilities as needed, although there are certainly less facilities of last year than there had been previously with the slow down in the economy.

When we build a new facility, we obviously put in most of the technology that has been proven to provide benefits.

At this point in time, we have about 20 facilities around the county that have automated sort systems.

The vast majority of our facilities, even our older facilities have the automated wash alleys and then there's a lot of smaller type productivity improvements that we have.

We can't put it in most plants old or new. [INAUDIBLE]

As far as you the coming years are concerned, Dave, we expect the number of new facilities to open to be less than they were in the last few years in part because we are picking up some very nice facilities from Omni. And one of the things that we will do is, we will take those facilities and we will put some of our technology into those facilities and make them even more productive.

And on the sales force, what do contribute the increase in productivity to?

Well, there are a number of things. But the one thing that really jumps to my mind is how we approach prospecting.

We have a group of people in our marketing department that do one heck of a job in identifying good prospects to give to our sales force. That maximizes their ability to call on a customer and know if they have a uniform rental program already, what type of business they have, how many people they employ.

Are they conducive to wearing uniforms, et cetera. So, it's good quality prospects being given to a sales force so that we increase their productivity when they go out and call on those prospects. Secondly is the sales promotion materials that we give them, their credibility pieces. Explaining our product line, explaining our service systems.

Being able to differentiate Cintas from our competition is another big reason why we think they're more productive.

And then lastly is, the support that we give them in the office. We know that we've got a great chance of getting a new customer but you've got to get in front of that customer. So we want to maximize the time that our sales force is actually out meeting with prospects. And that means they have to have great back office support, and that's what we do.

Is the productivity function, is that new?

No, this is not new.

I mean, we improve it each year with some additional support from our marketing department, but it's been a constant measurement that we've had in our Company. We measure the amount of new business written by each sales person within each business segment that we have.

Thank you for that.

You're welcome.

Thank you. Our next question will come from Steve Jacobs with Piper Jaffray.

Good morning, Bill and Karen.

Congratulations on a good quarter.

Kind of two follow-up questions to what's already been asked. And I'll just make a statement, Bill, you tell me if it's true or false.

Due to your productivity sales increase, your productivity increase in sales, that your head count in sales, is less than your year over year increase in new business of 17%.

True or false?

Well, first of all, before we answer that--

I tried real hard it get it through.

You always try that.

Let me just add something about this whole comment about productivity improvement.

If we look back at the last four quarters of fiscal '02, we cannot say that we had productivity improvement in the first two quarters. OK?

What we ended up at the end of fiscal '01, and what we realized in the amount of new business written by our sales force in Q1 and Q2, we actually went slightly down.

So, what my comment is, is that by the time we have gotten to this fourth quarter, that's where we saw the productivity improvement.

So, I don't think you can make a statement, we don't want to make a statement that the productivity for the full year was at a record level, ok?

Therefore you can't just make that statement that you just started off with in that question.

So the answer is false.

On your guidance with regard to '03, maybe some directional help with regard to your margins, both at the gross and at the operating line. What do you think?

The margins will certainly improve as we go through the year also, and the reason is a couple.

One is that the Omni business, you know, early in the year, is going to have less profit impact that it will have later in the year, due to the fact that we're just working on improving that profitability. So keep that in mind.

Secondly, we historically have always had our lowest margin quarter early in the year.

In fact the first quarter typically is because that's the quarter where we're rolling out a lot of new initiatives, we've got a lot of new people coming on board, staffing for the year, et cetera..

So, as you do your modeling, you should certainly take into consideration, not only that sales growth will be better in the latter half the year, but also the profitability will be greater in the latter half of the year than it will be in the first half of the year.

Sure. OK.

My last question again, is a follow-up to a previous question.

How many facilities do you have, new facilities do you have, targeted to open in '03.

Three.

About three.

OK. Great.

Thanks a lot.

Thank you. Our next question will come from Bruce Simpson with William Blair and Company.

Hi. Good morning.

Do you have targets that you'll share with us for your '03 projected capital expenditures or operating cash flow?

Capital expenditures are, I would say a little up in the air right now because we're kind of seeing how this economy is going to develop and evolve, but Bruce, my guidance to everyone on CAPEX will be to use approximately $150 million.

As we go through the year as we typically do, we will talk about that each quarter.

As far as operating cash flow, we're expecting before CAPEX, operating cash flow to be approximately $300 million plus.

Okay.

Thank you.

Then shifting gears, I wonder if you'll give us any kind of update on where you are in the roll out or beta stage of any new products or how many there might be out there or regionally. Are they beginning to click? Thanks.

We are certainly testing a few new products and services in various operations around the country.

We are not prepared to discuss any of those in detail right now.

We are having very good success in a number of them, but we're being cautious in making sure that we believe it will be a valuable addition to our customers before we really fully roll it out.

Is there a reasonable time frame when you might expect to begin talking more tangibley about any of those?

I would say my expectation would be that you'll start to hear us talking about some of the specifics in the next 12-18 months.

Okay, and then lastly, I'd like to probe a little bit more about the uptick in the direct sale part of the business. That looks fairly encouraging.

And I realize it's a lumpy business and sort of hard to project, but does that feel like it's just sort of a seasonal thing tied to the weather or is it more broad based than that?

I know you mentioned a little bit more about more quoting and RFT's. Is it beginning to feel, is it just working on backlog from September 11th or do you think that is it more of the economy beginning to approve at a grass roots level?

Anything you can give on color?

I think it's definitely a sign of improvement.

We believe that as we told everyone in the last couple of quarters, that there is certainly is a pent up demand that gets created when you have the economic downturn such as we had, especially in the traditional direct purchasers of uniform.

And we're seeing improvement in much of the travel industry, especially in the hotel business. The casino business with regard to uniform purchases.

So I feel pretty good that things have improved and that what we are seeing is a real move up from the trough that we were in back in our second and third quarters.

Okay. I know that you are going turn and rebrand Angelica as Cintas, so it won't really be a separated division, but for the purposes of modeling in '03 in direct sales, would it be logical to assume that contribution kind of stays at $45 million or perhaps grows since it's already fully integrated by the beginning of your fiscal '03?

What I would assume Bruce, is 45.

Remember what Karen said earlier.

It really becomes very difficult to track this because we did share some customers and it's hard to really predict what came from Angelica, what came from our own direct sales business.

I think one of the important things is that Angelica was one of the few national players other than Cintas that existed in this market place.

And therefore, if they're no longer in that business, that should give us some additional opportunities.

We expect if the economy stays strong or gets strong, I should say, we expect 2003 to be a very good year for our direct sale business.

OK. Thanks for your time and congratulations.

Thank you.

Thank you. Our next question will come from Kenny O. with SAB Capital.

Hey guys, congratulations on the quarter.

Thank you.

I actually just had a quick question about the internal growth rate you mentioned.

Pricing was up 1.5% and new business contributed about 17%.

Right.

And basically lost business was about negative 7.

So when I kind of add it all up, the 1.5 minus 7, 9 minus 5.5 plus the new business of 17, gives me sort of positive 11.5.

There's probably some add-stop negative drag, but the organic growth was 4. I can't wreck out what the difference is.

I was just wondering what I'm missing.

First of all, you're trying to wreck out fourth quarter and the numbers you're using are really for the full year.

Oh, oh, when you guys gave the organic growth numbers, I'm sorry, the component numbers, those were for full year?

Yeah, the 17% was for the new business for the year.

And lost business came in around 7.

The interim growth rate in the rental group for the full year is about 6.5%.

So, using the numbers that you started with, the 17% new business, 7% loss, a percent and-a-half price increases, we calculate that add-stops probably cut about 3-4 percentage points off that growth rate.

And in addition that, Kenny, what we have is when you have turnover within customer ranks and those people that are laid off or terminated are not replaced, we do sacrifice some additional revenue potential.

Because normally when they add on a new person, we get some additional revenue for making up the garments, for installing them for the first time, and some additional charges. And because that churn is not giving us the ability to get that revenue potential, that is clipping our top line by another 1-2 percentage points.

I see.

If you actually look at the quarter, did you guys state the numbers for the quarter in terms of the pricing?

I don't have the numbers for the specific quarter.

Okay.

Thank you.

You're welcome.

Thank you. Our next question will come from Thatcher Thompson with CIBC World Market.

Morning Bill and Karen. When you have a slow down, now that you've kind of lived with it for, I don't know, what are we talking about, about twelve months here?

Yes.

Is there a natural improvement in the margin because you're not putting as many new uniforms into service?

You tend to use older inventory.

Can you tell me how the dynamics of that works and the slow down and how it would reverse or change in an acceleration of growth?

That is a phenomenon that certainly happens, Thatcher. If you're in an environment where we have many of our customers reducing the size of their workforce, that increases the amount of used uniforms that are coming into our stock rooms in our various facilities. And therefore, we have increased inventory of used uniforms, which by the way, even if they're not being used in a customer, are continuing to be amortized, we have the increased inventory.

And therefore, when we go to replace a uniform for another customer, we're often able to find that used uniform sitting in our stock room.

Now, conversely in a growing environment, a very fast-growing environment, we tend to have less used uniforms available for reuse.

And therefore, we're having to go out and inject new uniforms bringing them in from our distribution centers or manufacturing facilities, and basically injecting them into the customer base.

Therefore we have an increased cost going on because now we have more uniforms and service and once they go into service, the amortization of that uniform starts. If we were to go into a rapidly increasing growth environment, you would tend to see an increase in our material cost because of that phenomena.

Plus the fact that all new business gets new uniforms, and all those uniforms are coming into service.

Is there a way to quantify the impact over the last twelve months of an increased inventory of used uniforms on the margin?

I don't really have that.

We know that some of our margin improvement in rental though was certainly for that.

And yet you have more uniforms still being depreciated but don't have a body in them.

Right.

OK. So that's kind of an offsetting factor.

Correct. Well, that's right, because you don't have the revenue there.

Then another question.

The 80 Omni locations, 40 overlap.

After seeing some of your locations, it's hard to believe you can almost double the flow of uniforms going through them without knocking out a wall or building a new building.

How much capacity do you have to combine locations and I would think that there would be some CAPEX associated with this integration.

Let me just give you one example of this right here in our back yard in Cincinnati.

There was an Omni operation in a small town just north of our corporate headquarters. That volume actually was consolidated and split up between four Cintas locations. So the ability to absorb it, when you break it down into those pieces, Thatcher, you don't have a lot of CAPEX. I don't think we had any CAPEX in any of those four locations in order to absorb that one location's volume.

OK. Is there a measure of capacity that do you? I know you can always add a night shift, but are you operating at 50, 60, 75% capacity?

We think we're running at about 80-85% capacity, but Thatcher, we have some facilities that run at 130% capacity.

I know that doesn't sound feasible, but the interesting thing about our business is that there is different components of capacity within a facility.

You have hanging capacity, you've got washing capacity, you've got sorting capacity.

You really can't look a at facility and say, well, how much capacity do you really have? Because we often can just add another shift as you suggest.

We can add another washing machine, we could add some additional rails within the facility to do some storage.

We feel very comfortable that we can absorb this Omni volume in those facilities that, the Omni facilities we're shutting down.

We feel very comfortable that we can absorb that in ours, without any significant increase in CAPEX.

Thank you. Again, if you would like to ask a question, please press star one.

We will now go to Michael Snyder with Robert W. Baird.

Just a follow-up on the guidance for next year.

It appears to me your target range for net margins has historically been 10-11%, is that correct?

Right.

If I like at the $2.8 to $2.9 million dollars in anticipated revenue, it appears that even the high end of the range assumes 10%.

Is it because you will start the year off below that threshold due to Omni?

I guess I'm just scratching my head that Omni would have that large an impact on the first half.

Omni certainly is going to have a diluted impact on the margins, Michael, especially in the first half, but you know, the other phenomena go back and look historically, you know, the first part of the year always tends to be a little less than 10%.

So I think when you work through your numbers, given the fact that we're anticipating greater growth in the later part of the year that has a little pressure on margins, that may be why you 're coming in at the low range of that 10-11% when you apply that to the revenue guidance.

But is it fair to say though, that even the high end of the range assumes the low end of that 10% range for the year?

Right.

Yes, it does.

That's all, thank you.

Thank you and we'll now have a question from Chris Gutek with Morgan Stanley.

Thanks, Karen and Bill, quick follow-up. A couple of quick follow-ups here.

When I take the total acquisition spending for the full year, and back out what I assume is allocated for Omni, and Angelica, and back out the first three quarters of the year, if I've done the math correctly, what I'm coming up with is $24 million for tuck-ins in the fourth quarter, which would be a somewhat higher run rate than you guys have done for the last couple of quarters.

Bill, I think you made the comment on fiscal third quarter call, that you saw the environment for tuck-in acquisitions improving significantly. I was wondering if you can kind of comment on the numbers, if I've done the math correctly, and then more qualitative comment about the opportunities for tuck-in acquisitions going forward.

You have done your math correctly, Chris.

We did had some tuck-ins especially towards the latter part of the quarter, really didn't have any appreciable impact on the quarter, but will going forward. We're seeing increased interest on the part of many of the smaller players in the industry.

Looking for an opportunity to sell their business. And this is what we've been predicting all along.

As the recession in our industry continues, companies are going to be more willing to sell than they have been before.

We are seeing increased interest, we picked up a few tuck-ins toward the later part of the quarter as I mentioned.

It's hard to predict acquisitions going forward, but we're having a number of discussions with various companies around the country.

OK. Great.

A couple balance sheet questions, if I could. The accrued liabilities is only up $10 million sequentially, in spite of $49 million coming from Omni.

Kind of curious what was happening there.

The accrued liabilities, there is four less days accrued in our compensation versus the previous quarter.

There were nine days accrued at the end of February and about five days at the end of May.

So we've got four-day differential there, Chris.

Makes sense. And then the inventory of new uniforms was down sequentially in spite of the additional inventory from both Omni as well as Angelica.

I know there's been a trend over the last year, year and a half or so, of filling new distribution centers that were started up previously with declining inventory, but still was surprised to see that with the new inventory coming from the two acquisitions.

You're right. If you carve out the inventory brought in from Omni and carve that out of the balance sheet, our inventory declined year over year by about 15%.

And that is, as you say with a concerted effort to trim down those inventory levels after they had gone up as a result of building those new distribution centers last year. It was just in response to the slow down in the economy.

It's something we had to do.

It's just an example of how we cut costs in this Company.

OK. Thanks. And then finally, real quick, back to the purchase price allocations for Omni. I guess you have about 12 months to make modifications. I'm curious if you more or less finalized the purchase price allocation, and secondly if you could talk a little bit about the allocation between goodwill versus other intangible assets.

Chris, we have just received the final balance sheet from the seller. We're in the process now of reviewing that balance sheet and making sure that it's appropriate with regard to our set up of the balance sheet that we have previously disclosed.

Certainly as we go through the year, we'll be firming up some of those numbers and adjusting them modestly I would say.

Right now we're estimating that our goodwill will be approximately $500 million. And our amount allocated to service contracts will be about $100 million.

OK. Great. Thank you.

Thank you.

We have no farther questions in the queue.

I will turn the call back over to you, Mr. Gale. Actually, we do have more question from Bruce Simpson.

Just following up on the prior question, I wonder if you can comment on acquisition pricing outside of the big ones like Omni.

Just the little tuck-ins where it is, and where it is relative to where it was a year ago. Thanks.

Bruce, I don't think there's any appreciable change from where it was a year ago, and again when we look at an acquisition, we look at the contribution it can make to our Company and our shareholders.

So, I would say that we're not seeing any dramatic change though in the pricing.

Okay.

Just kind of anything you're willing to share on the absolute level in either a multiple of revenue or profitability.

I can't really do that and it's not because I don't want to, the thing is, is that it varies so much by the business you're buying.

Profitability with privately held companies is not a real meaningful number, if you look at their historical profitability.

And what do is, we look at it on a forward basis when we bring it into Cintas. As far as the multiple of revenue is concerned, you know, again, that varies depending on the customer mix. the product mix, how good is their contract coverage, how big are their accounts, et cetera.

So there's really no good rule of thumb.

It's basically done on a case by case basis.

Thanks, Bill.

Thank you. At this time we have no farther questions in the queue. I will turn the call back over to you, Mr. Gale.

Thank you all again for joining us.

We appreciate the interest in Cintas.

As Karen said before, we are working very hard to achieve our 34th consecutive year of growth and earnings and profits.

We'll look forward to talking with you again in September.

Probably the late latter part of September when we release our first quarter results.

Thank you. That concludes today's conference.

Thank you for participation and have a great day.