信達思 (CTAS) 2003 Q1 法說會逐字稿

Good day, everyone, and welcome to the Cintas first quarter 2003 earnings release.

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.

We welcome all of you today to discuss our first quarter fiscal 2003 results.

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

After some brief comments, we'll be happy to open the call to questions.

We are pleased to announce record sales and profits for the quarter ending August 31st, 2002.

Total revenue for the first quarter increased 18% to $666 million and net income increased 9% to $62 million.

These numbers include the impact of the acquisition of Omni services made in May of 2002.

Additionally, this year's's first quarter had one workday than last fiscal year.

On a comparable basis, rental revenue and other service revenue rose 23% and 10% respectively.

While we are pleased to have increased results for the first quarter, we continue to see shrinkage among the customers within their own businesses.

Many customers are continuing to reduce work forces, thereby reducing our revenue.

On the other hand, new business efforts continue to set all-time efforts.

As we have stated previously, Cintas will aggressively pursue new business and when the economy improves, which it will, we expect to be in a positive position relative to most other companies.

As noted in our press release, our current estimate for full year revenue for our fiscal year ending May 31st, 2003 will be between $2.7 billion and $2.8 billion.

With earnings per share in the range of $1.55 to $1.62.

When compared to the guidance we gave in July 2002, the revenue numbers were lower due to the sluggish economy; however, we continue to be confident in estimated earnings per share due to the aggressive cost control efforts going on within Cintas and the positive impact of Omni.

We also continue to aggressively control capital expenditures.

As noted in our cash flow statement, capital expenditures for the quarter were approximately $22 million.

We now expect capital expenditures for the year to be approximately $125 million.

The integration of Omni continues to go well.

We are well on our way to achieving our consolidation of facilities.

We have achieved the majority of the integration of corporate functions from Omni's headquarters to Cincinnati.

As is typical with any acquisition of this size, the initial lost business is higher than the Cintas norm in the first few months.

Stabilization has occurred.

Minimal other acquisitions made during the quarter.

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 discussions on these points contained in the most recently filed form 10-K.

I will now turn the call over to Karen Carnahan for further discussion of our results.

Good morning.

I would like to take you through our income statement, cash flow statement, and balance sheet in a little more detail.

We have upgraded our website with our first quarter financial results.

You may want to go to that section of the website to have the financial statements in front of you as I explain the numbers.

When you pull up the first quarter news release, the first few pages will be the announcement itself and then the last three pages will be the income statement, cash flow and balance sheet.

I will first start by commenting on the income statement.

Total revenues were $666 million for the quarter and 18% increase over that reported in the prior year.

Our rental revenue which represents 79% of our business increased 21 percent over the prior year and other services revenue which is predominantly the sale of uniforms increased 8% over the prior year.

Before we get into the details about our sales growth, we want to give you a brief overview and perspective of the top-line numbers.

As our news release noted, we had one less workday in the quarter versus the first quarter of last fiscal year.

In other words, we had 65 workdays this quarter versus last year's 66 days.

One workday accounts for approximately $8 million of rental business and 2 percentage points of growth year over year.

This quarter includes a full three months of Omni's operating results.

Omni services is a company we acquired in May.

The Omni business is predominantly rental business and is a great fit with our business.

We will talk further about the consolidation in a few minutes.

Omni contributed approximately $70 million in revenue in the quarter.

Smaller acquisitions also contributed to the top-line growth during the quarter by 2 percentage points.

So in the first quarter our growth in the rental business was 23% including the workday differential.

Breaking that 23% growth rate down further, acquisitions accounted for an 18% growth rate and internal or organic growth of 5% accounted for the remainder of the growth in the quarter.

I would like to focus on the 5% organic growth rate for a few minutes before we move on.

A 5% growth rate in the quarter represents approximately a 100 basis point improvement versus what we reported in the fourth quarter of last fiscal year.

This improvement came from several areas.

First, our business with new customers is still growing at a healthy pace.

This really is not new for Cintas.

Last fiscal year our new business increased 16% over that written in the prior fiscal year.

This first quarter of the new fiscal year is coming in at higher levels.

We obviously are very encouraged with what we see in the new business arena.

Our sales force continues to experience success and improve the productivity in writing new business.

We are having some strong results on the east and west coast as well as the mid-south and Great Lakes regions.

New business is coming in from no programmers, those who never had a uniformed program before and we're taking business from the competition as well.

For the quarter new business written increased 20% over that written in last year's first quarter.

Our lost business is still above historic levels but it is improving as well.

Last year our lost business was 7% and during the first we are running slightly below that level.

This lost business statistic includes some lost business from the Omni acquisition.

In tracking the Omni business that we have lost to date, we note that it is running at levels fairly Nevel for acquired volume.

There is always a certain amount of acquired business that is unattractive to keep whether it is priced too low or the cost to service to business make it uneconomical.

We evaluated the Omni business and will continue to do so through the next months.

Our existing business with rental customers declined in the quarter which has been a trend over twelve months and a reflection of the tough economic climate we are in today.

The good news here is that the trend is improving.

For example, last year's shrinkage in business with existing customers clipped our growth by approximately 300 basis points.

In this first quarter, we are on an annualized pace where the shrinkage is 100 basis points.

A definite improvement.

The bottom line is we are not back in positive territory and not in recovery yet.

Price increases have declined compared to last year.

Although, we are in the beginning of a new fiscal year, price increases so far have only accounted for a% increase in rental business.

This compares to price increases of 1 1/2% last fiscal year.

Our price increases are clearly defined and primarily hinge on the change in the consumer price index.

Although it gives our general managers latitude to increase prices by the CPI or 5% which ever is higher, it is tough to get price increases in today's economic climate.

Before we move on, let me recap what we see in the rental business in total.

First, we are getting a healthy increase in all business across all our product line.

This includes uniform programs and uniform rental.

Price increases are around the 1% level so far for this fiscal year.

Third, we continue to experience shrinkage in the existing rental business during the first quarter.

The trend is improved from what we saw in the past three quarters and lost business has stabilized and just below the 7% level.

This metric also includes some undesirable business that we did not want to keep from the Omni acquisition.

The sluggish economy continues to hamper our ability to make a major breakthrough in organic growth but it is encouraging to show a 1 percentage point improvement over the fourth quarter due primarily to continued success in writing new business and convincing companies to adopt a uniform programs for the first time.

Although the business with our existing customers is still shrinking, that shrinkage is at a deccelerated pace which is positive news.

This will be the only quarter of the fiscal year where our comparisons to the prior year are extremely difficult.

Next quarter and the remainder of the fiscal year, the comparisons will be easier.

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

Other services revenue increased 8% over last year.

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

Uniform sales for the quarter were up approximately 7% for the quarter.

And adjusting for the one workday differential, that rate was 9% compared to the first quarter of last year.

This was a significant improvement compared to the past quarters.

The uniform sales side of our business was dramatically impacted by the tragedy of September 11th.

Our customers had delayed the purchase decisions until they had a clearer indication on the direction of their businesses.

Our customers are showing signs of upgrading their uniform programs and we see opportunities to continue to increase our uniform sale business.

The first aid and safety business and clean room sales also showed nice growth compared to past year, each increasing by high single digit rates.

Now let me move on to address our margins.

First our rental margins.

Our rental margins for the quarter were approximately 46%.

We are aware that we'll have some reclassification of cost between cost of rentals and cost of sales that will be made before we file our 10-Q.

These reclassifications will not change our bottom line results.

They are merely reclasses between the two line items.

Our rental margins improved in the quarter over last year primarily resulting from expenditure control, improved productivity in our rental facilities and the synergistic impact of the Omni acquisition which brought $70 million in topline revenue in the quarter.

This $70 million of Omni business had been served by 80 Omni facilities.

Today approximately 25% of those former Omni customers are now being served by a Cintas operation.

Since may 31st, we have also closed 31 of Omni's facilities and now Omni customers are either being served from a Cintas location or one of Omni's remaining 50 operations.

We intend to consolidate another 14 operations by the end of the fiscal year.

Last quarter we talked about the importance of converting Omni computer systems over to ours.

This is a critical step in the consolidation and allows us to implement our service systems, our rental product line and gives us the ability to cross sell our products.

We are ahead of the original schedule in that conversion cycle and will be done before December 31st.

All aspects of the Omni integration are going extremely well.

The vast majority of the corporate office functions have been brought to Cincinnati and to our corporate headquarters here without any major disruptions to our business or to Omni's business.

We are very pleased with what the quality of Omni's business and the positive impact it will have for our shareholders.

Now going on to other service revenue margins, again, as I mentioned before, we'll have some reclassifications between cost of rentals and cost of sales, such that these margins will be higher than what is reported here.

The mix of our business from quarter to quarter makes these margins fluctuate.

For example, depending on the customers who purchase uniforms during the quarter, the growth margin can be different due to the level of service we are providing.

Some customers require a very customized uniform program which is higher margin business for us while others require a more basic program which is priced more economically for them.

Going on to selling and administrative expenses, our SG&A expense was 26.6% of revenue, and a 100 basis point increase from last year due primarily to two things: First the amortization of acquisition costs related to Omni, and, two, the duplicate general and administrative costs from Omni during this period of integration.

Our net interest costs were 1.1% of revenue compared to previous year's 3 tenths of a percent.

Our average interest rate for our outstanding debt is approximately 4%, including a recent financing for the Omni acquisition.

So far this fiscal year we have been able to reduce our interest expense even further by paying down approximately $50 million of that acquisition debt.

Our effective tax rate was 37% for the quarter which is consistent with the prior year.

So for the quarter, net income was $62 million compared with $57 million in last year's first quarter with earnings per share up 9% to 36 cents per share.

Looking at the cash flow statement for a few minutes, there are a few items of note.

Cash flow from operations increased 16% during the quarter to $70 million.

Capital expenditures as Bill mentioned were $22 million down from $33 million last year.

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

For the year we expect our capital expenditures to be approximately $125 million.

As I mentioned before, our healthy cash generation allow us to pay down approximately $50 million of acquisition debt.

Looking at the balance sheet for a few minutes, accounts receivable is in great shape with DSO's of 39 days and that is comparable to fourth quarter.

Our accrued liabilities declined by $45 million sequentially from last quarter which is also reflected in our cash flow statement.

Consistent with past practice, during the first quarter we funded our estimated medical benefit costs for the year into a VIVA trust and we funded our contributions to our partner's retirement plans based on fiscal year's 2002 results.

Offsetting those reductions in accruals during the quarter, we had an increase in accrued interest of approximately $5 million for the Omni debt.

In summary, our company is very strong financially.

We are successfully executing a well-orchestrated plan for integrating the Omni acquisition and we are pleased with the quality of customers and the people that join the Cintas organization.

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

Now we would like to open the call to answer your questions.

Thank you.

The question and answer question will be conducted electronically.

If you would like to ask a question, press star followed by the number 1 on the telephone.

We will proceed in the order you signal us and take as many questions as time permits.

Our first question comes from Greg Capelli with CS First Boston.

Good morning.

It's Clayton in for Greg.

A few questions for Omni, can you remind me what the expectations were for the revenue contribution was for the full year?

Originally we estimated about $300 million, Clayton.

I would say at this point in time, I would update that to say it's probably going to be between $290-300 million based on what we saw in the first quarter.

And as you provided color because of those accounts where you thought were undesirable?

That coupled with the fact that Omni customers are like Cintas customers in that they continue to shrink, also.

The first quarter was a little weaker than we had expected to be in our existing businesses.

I think that has some impact, too.

We don't see that recovery necessarily happening until later in the year.

Okay.

That's helpful.

On the cost front, however, and appreciate the color you provided on how many plants are being transitioned here.

I originally anticipated 40 facilities to be merged and I think you're talking about 45 at this point.

Does that give you an opportunity to exceed your goal from a cost-saving standpoint?

The answer to that is, yes.

I wouldn't put tremendous dollar impact on that because what we're talking about here is maybe some branches we thought we were going to keep open.

No longer going to keep open.

We'll have a positive impact but, again, talking a relatively small amount.

Okay.

And lastly, just house keeping wise, you mentioned the reclassification of some costs in rental and direct sale.

How much do you anticipate that being for the full year?

Well, it's basically just a quarterly adjustment here.

Clayton, and every other caller, what we are estimating right now is that our cost of other services instead of 71.6% after the three classes will be somewhere between 69.5 and 70.5% and that would leave cost of rentals to be approximately 54.4-55.5%.

And what exactly is the reclass that's being shifted?

It's just getting the right categorization of distribution costs and other type items into the appropriate groupings.

Okay.

Thank you, very much.

And our next question comes from Michael Snyder with Robert W. Baird.

Good morning.

Maybe further questions on Omni.

The sales force that was certainly an unexpected high number of turnovers related to the Unitog acquisition, could you give us a sense of what the expectations were at Omni and what pace you're on right now in terms of sales force turnover?

We originally expected as we indicated in the July call we thought we would retain 40-50% of Omni sales force.

At the current time, I would say that number is closer to 20-25%.

We found that the productivity of many of the people just doesn't seem to be -- they don't seem to be capable of achieving our levels, and therefore rather than trying to stretch it out longer, we decided to go ahead and make the changes earlier rather than later.

We are disappointed that we'll have to replace a few more sales people than we originally intended.

Could you give us a sense in absolute numbers what we are talking about? 150 sales people roughly?

They started with 120 people.

So we'll end up keeping 20-25% of those.

And those of us remember Unitog, this was the source, the additional sales turnover was a source of disappointing growth in the following quarters, how do you avoid that scenario this time around?

We did not let that happen.

We built up the sales force throughout the company a year ago and we continued to keep them up there and held our general managers accountable for that.

So that will not be an issue and that is evidenced by the new business we continue to write quarter after quarter.

That will have no impact on us.

But is it fair to say that today you produced your revenue guidance for the year by about $100 million.

Some of that stems from the Omni turnover?

No, it does not.

The reason for the revenue reduction is primarily driven by two things.

One, our results for the first quarter is revenue were not as high as originally expected due to the sluggish economy.

Totally due to the economy and what's impacting our they reduce workforce, shut down operations and reduce shifts, etc.

Any revenue we lose in the first quarter tends to remain lost throughout the year until the economy starts picking up.

As we look at the economic situation, we don't see any substantial improvement happening in the near term and therefore, I'd say our revenue guidance adjustment is to reflect a more pessimistic view of the economy for our fiscal year ending May 31st, 2003.

I agree with that latter statement.

The start of that, though, you said presumably the add-stop ratio was less negative than -- I'm sorry, more negative than you had anticipated.

Yet the in percentage points of growth, you mentioned that last year, add-stop shaved 300 basis points in the first quarter, shaved 100 basis points, are you saying then that your expectations for the quarter had actually been less of an impact on add-stops?

Yes, we actually hoped we would be back to flat because what we were seeing at the end of the fourth quarter was we started seeing positive improvement in that metric.

Once again that just didn't materialize, and even though it was an improvement like we said, it's about a third of the rate of what we experienced in fiscal '02.

It didn't get back to flat.

Until that shrinkage stops, you know we're not going -- we're going to have to refine the estimates like we did today.

Okay.

And final question, in terms of the Omni impact on the P and L this quarter, can you quantify how much in severance costs, relocation costs, whatever they were that was run through the P and L for this quarter?

There were no severance costs run through the P and L this quarter, Michael.

Because the severance that we paid out to Omni for the programs that were in place at the date we acquired the company and therefore were accrued at the opening balance sheet.

That's not to say there might have been a few thousand here and there that weren't anticipated that would've fallen through, but it would have been immaterial.

With that computer conversion cost, consulting fees, et cetera.

All that was absorbed in the quarter, offsetting any profit contribution from Omni.

As we talked last time, yeah, we expect the profit contribution from Omni to be about 3-4 cents a share for this fiscal year with most of it happening in the latter half of the year.

There basically was little profit contribution from Omni for the first quarter.

That was what we expected the case to be.

Right.

Thank you.

Bruce Simpson with W.M.

Blair has the next question.

I'm having trouble getting to the internal growth rate given the various components that you ran through.

Did I hear you correctly saying new business written was up 20% year over year?

That's right.

That's commenting about the amount that's written in the year.

It doesn't equate to a top-line growth number for the current quarter, necessarily.

I don't know if this is the right time to talk through that because we get that question quite a bit.

When we go through the metrics on the conference calls, they are not meant to be a mathematical breakdown of the top-line growth.

What we are trying to do is give everybody insight on how we track the week to week business and there are four major components in looking at week to week growth.

New business, lost business, price increases and then this add versus stop orders within existing accounts.

What we are looking at is those four key indicators in looking at week to week growth.

When you convert that to topline growth for a rental business many times those statistics come through on a delayed basis.

Let me give you an example.

If you wrote new business in the 13th week of a quarter, you obviously would have topline growth from that contract.

Contract that with if you wrote the business at the beginning of the quarter you would have 13 weeks of revenue for that quarter.

What we are trying to do is get into detailed metrics of how the week to week performance is broken down and then we hope what you do with that is create a mosaic to predict topline revenue for the company going forward and also you can get an appreciation for the trends going on within the week to week growth.

Does that help?

Let me address in calculating internal growth for the quarter, we have also made the adjustment for that one workday.

When you say 5%, is that adjusted or unadjusted for the extra workday?

That is adjusted for the extra workday by adding in an additional $8 million for that one workday within that rental business.

Okay.

So the fact that in prior quarters it seems like, you know, thank you for the explanation but it does seem like in general those numbers were closer to when you assembled them to the reported internal growth rate while this quarter it's a little more difficult to adjust those, does that suggest just what you used as an example that perhaps things improved in the back half of the quarter relative to the early half?

Yes, but more important than that is when companies that are in this business see a change in a trend, in a particular quarter, you won't see that go to the topline until you get into a second, third and fourth quarter.

When we see a trend like in a reversal of the shrinkage within existing accounts going from 300 basis points to 100 basis points, that will not translate into topline growth until we get further into the fiscal year.

That's wat that means.

Okay.

Just to follow up on that, in terms of your expectation for Omni, Bill I think you made a comment about will continue to evaluate how much business is unprofitable and so forth.

Netting out any impact of the economy as a whole, you are on an annualized 280 basis now.

Should for the process of modeling, do you expect that to be good moving forward or a seasonality which would have made this a weaker quarter or would you expect it to continue to deteriorate a bit as you discover operations as you go on service?

My expectations are that it should not deteriorate further.

The worst period is always the first couple of months.

That's why I said earlier my expectation of revenue built into our numbers between 290 -$300 million for the year.

Okay.

And last question if I can talk about SG&A as a constant dollar amount rather than as a percentage of revenue, so it was about $24 million higher than in the May quarter and from a modeling perspective moving forward, are you anticipating more closures bring that down as a total dollar amount?

Well, it will bring it down from the standpoint of closures and G&A costs, yes, they will be brought down.

But as you know we continue to always increase our sales force, increase selling costs, marketing costs, et cetera.

My expectation would be that I would look at it on a percent to sales basis and my modeling would be to trend down from a 26.6% level to closer to 25 1/2% by the end of the year.

Thanks, so much.

Now hear from Chris Gutech with Morgan Stanley.

Good morning.

I'd like to follow up on a previous lines of questioning.

Which is the liabilities created at the time of the acquisition for severance, other integration costs, that was listed in 10-Ks, I'm curious what portion of that has been paid?

The amount that's been paid so far is $5 million of that.

We don't expect the accrued liabilities that were in the opening balance sheet basically to change too much going forward.

Okay.

Bill, you mentioned that a portion of the integration costs were being run through the P and L for consultants to switch over to the IP systems.

Can you quantify that, the nonrecurring incremental expense in the first quarter?

I'm sorry, Chris, I don't have that number.

And putting aside the integration of Omni, the historical business, it was mentioned several times in the release and you mentioned in your prepared comments being aggressive about cost reduction, are there any areas that you are focused on and any head count reductions in the quarter?

No head count reductions per se, there are head count controls that exist.

Give you an example in my own particular areas of responsibility.

I have been very, very careful on adding head count even though we have a significant amount of business.

More revenue that we're having to control or operations we have to control.

I've been very, very careful on adding that head count.

I've been careful as all parts of Cintas have been on travel and training-type programs.

Anything that could be discretionary.

We decided to be careful to try not to add those costs until we are truly confident that economy has improved.

I would say also we're finding that we're going to our suppliers continuously and asking them to work with us as we bring them more volume especially related to buying companies that should give us additional price reductions and we've been successful in doing that.

It's just a general cost control, general attitude about how to run a business in these tough economic times.

I know you mentioned in the last call, systems integration, one potential risk area would be the acquisition integration but that seems to be going smoothly.

Another is the retagging of the Omni garments.

Can you tell us how that is progressing?

That's progressing.

We ran into a few more issues doing that than we originally had expected.

We were hoping to do some mechanical conversions of some of those garment tags.

Unfortunately, the condition of some of the tags on the Omni garments wouldn't allow us to do that.

It has increased slightly the amount of effort we had to expend.

It is moving along in conjunction with the closing down of the facilities.

It's one of the primary things we have to do before we can move the business into an Omni facility into a Cintas facility and we're in good shape there.

Okay.

I noticed your inventory was up 10% after many quarters of declining sequentially.

My understanding was that the intention was to use the existing new uniform inventory from Omni as opposed to replacing and surprised to see the increase.

The reason we are doing that, we are being very successful in using up the Omni inventory.

Omni operated when they got their goods, they were operating on a consignment basis.

We are certainly going to transition out of the Omni uniforms relatively rapidly into the Cintas uniforms as we replace existing garments as inventories are depleted.

In order to do that, we have to get the fabric and work in process into our manufacturing process.

We manufacture most of our core rental garments.

So the buildup is driven in large part by the fact we are ramping up for the Omni rollout or the roll-out of our product into the Omni locations which was expected to be done.

Additionally we always see a runnup in inventories prior to the Fall because our catalog business is strongest in the Fall and prior to the holidays.

We are also seeing pickup in our business and direct sale business as Karen alluded to and we need to make sure we have the appropriate inventory in place to handle that.

If you look at our inventories relative to the prior year at this time, we are right in line and higher than where we were in May and that was by design.

And a quick update on the status of your healthcare and workers comp contracts in terms of when they come up for renewal and what you're expecting in terms of cost increases?

We are self insured for both of those.

We incurred increased cost as we go.

Obviously we have providers to perform the administrative functions for both programs and continue to see increased cost in both those areas.

I would say more so in the healthcare than the workman's comp.

The healthcare the way we handle that is we basically pass on some of that cost to our partners or employee base and continue to use our clout, our purchasing clout in looking at providers to establish preferred provider organizations around the country to keep our costs from increasing quite as fast as the general medical costs are in the country, but no question that we are seeing higher costs in the medical field and we are having to figure out how to absorb those costs into our system.

Great.

Thank you.

And our next question is from Amanda Tupper with JP Morgan.

Good morning.

A couple of questions going back to the margins.

First SG&A, then growth margins.

The explanations you gave were different than I anticipated.

So you're saying the SG&A being higher.

A lot of that comes from the Omni amortization and the amortization of the customer list, that doesn't go away.

I'm wondering roughly what that is running?

For the quarter, this is total amortization, it's about $7.6 million.

That shows an increase over the prior year of $3 million which is substantially due to Omni.

It ought to be around that extra million whatever else you do is going on, it's what, a five-year?

No, ten-year.

It will continue, Amanda, but the revenue will go up, too.

Of course.

Okay.

On the -- that's helpful, thank you.

On the growth margin side are you reusing more fully amortized uniforms as well is that part of why it's higher?

Because of continued negative add-drop ratio?

I don't think that's substantial, there is certainly uniform reutilization, because of customers shrinking work forces, but that was not a substantial piece of that.

So the bigger thing is just the operating synergies with Omni.

Yeah and you have better use of capacity.

You notice our Cap Ex is lower.

All of that comes into play, general cost control I mentioned to Chris a few minutes ago, that goes on in our operations also continuously.

I think it's a lot of those factors.

Where would you see, you gave guidance a few moments ago on SG&A for the rest of the year, for gross margin on rental, would you see that as getting slightly better from the first quarter's levels?

I don't think it'll get much better.

I think it will be comparable as the year goes on.

If growth were to dramatically pick up, you would see pressure on those margins.

That's right.

Okay.

And then just going down the income statement, my other question is on the interest expense which you paid off more debt than I thought and that was lower so I'm wondering, again, going out for the year, if $8 million would be a great run rate for the rest of the year?

Yes, it should be.

You would be paying off more debt in the next quarters?

I want to be conservative with you and I think 8 million dollars makes sense.

We'll pay down debt when it makes sense as we generate cash.

And finally on Cap Ex, is it mostly just new facilities you are not spending on?

Well, it's new facilities are a big chunk of the stuff but it's also trucks and equipment replacement rather than replacing a washer, we might decide to hold off for six months and make sure we really need that replacement.

We try to reutilize as much equipment as we can.

One thing about the Omni acquisition is they did a very nice job keeping their equipment up to date.

And we're finding a lot of use for their equipment as we shut down facilities.

That's going to help our Cap Ex expenditures.

That's terrific.

Thank you, very much.

Kevin Monroe is next.

Just focusing on gross margins.

I don't know if you go into this detail, could you break out where the 100 basis point improvement came from on the year over year basis.

You said there wasn't much, you said you are reusing, not manufacturing uniforms, where did it come from?

First of all, let me remind you we are going to have to make reclassifications between the two line items.

It will not be a 100 basis-point improvement.

It will be between 40-50 basis points.

But most of it does come from the synergistic effect of Omni and the other items that we just talked about which are productivity improvements utilizing the capacity to a greater extent, not building additional facilities, utilizing equipment much better than we have in the past.

The total focus on how we are spending our money now during the tough economic climate and while we are integrating Omni is showing the type of margin improvements.

Okay.

On Cap Ex with the reduction in Cap Ex, are you still on track for increasing automization in your plants?

Absolutely.

On any new facility that we build, we will put the most state-of-the-art automation in the facilities assuming those operations are projected to grow to a level that can utilize that effectively.

We don't put it into every facility if we think the facility is going to be smaller in scope.

We would not spend $1 million on automation but most do have that new automation in them.

How many of your facilities existing today would you -- what percentage are up to date with the latest technology and what still needs to be done?

The number of facilities today that have the automated sortation equipment, is approximately 20 facilities.

The amount of facility that is have an automated washroom operated by one person operating various washers and dryers, that's 50% of our facilities.

Okay.

And if you maybe can provide comments on what you are seeing in September in terms of shrinkage or continued demand for new businesses, we had not so great news on unemployment today.

What are you seeing more recently?

We are not seeing more improvement but not seeing deterioration.

We are seeing the same sluggishness we saw in the first quarter.

Okay.

Thank you.

Thank you, Kevin.

Now here from Steven Jacobs with Piper Jaffray.

Good morning.

Just a quick question.

In the past we talked about add-stop ratio for ancillary services.

Could you add any comments there or provide comments there?

That actually is doing better on the uniform side and totally corelated with the employment where as the other services that we had, the entrance and hygiene services, that is doing better and that is closer to a break-even standpoint.

So that provides some positive outlook as well.

Close to break even, close to being positive?

Correct.

For the quarter in general, Bill, based on your comment on the last question, in terms of the pace of the quarter, there wasn't any real strong trend one way or the other by month or by customer or region?

No, I would say there was not, Steve.

With the July call, we mentioned that the first couple weeks of June was looking good relative to May, but then I would say that things flattened out for the quarter and never really picked up again.

As far as regions of the country are concerns, we are not seeing much difference among our various regions.

And markets?

Any comments there?

The end markets, you have to get down into the different businesses to talk about that.

I would say in the direct sales business, we're seeing some comeback in the hotel area but it's being offset by the continued problems that the airline and rental car company seem to be having.

We are seeing big companies who have direct sale programs being very cautious on moving forward on new programs, continuing to maintain the programs, but they're not rolling out new things.

In our rental business, I would say that there still seems to be a weakness among manufacturing-type customers.

Most of our customers are in the service industries and we don't see a lot of exciting things going on there other than in attracting new business.

Existing customers seem to be doing what Cintas is doing and being cautious because there's not really a lot of great news sitting out there.

Thanks.

One last question.

Is your sales force increase, is a growth in your sales force at a faster pace than growth in new business?

No, it's not.

There is productivity improvement as well in the quarter.

Good.

Thanks a lot.

Now hear from Patrick Thomas from CIBC World Markets.

Good morning.

One question earlier mentioned the $36 million accrual for the Omni expected expenses integration costs, you paid out $5 million of that.

It seems you've closed 31 locations, 45 you intended to close, more turnover than expected, the corporate integration seems essentially done, what else do you have to spend the $30 million on?

Oh, a lot of different things.

Environmental cost that is will go on for years that we accrued a significant amount for.

The termination of leases associated with their buildings.

So that hasn't happened yet.

No, it hasn't happened.

Cars and trucks that we're no longer going to use.

We had the accruals for appropriate workman's compensation and legal liabilities that don't necessarily get paid out immediately.

You've got some associated costs with consulting arrangements, manufacturing arrangements that we'll phase out over time.

Okay.

All right.

And then, Karen, just walking quickly through the four major components of your growth, new business is about 20%, lost business was under 7%, price increases up 1% and add-stops again, what was that number?

That was a shrinkage, continues to be a shrinkage.

Let me clarify.

The 20% is the amount of increase in new business written in the first quarter vs. what was written in the first quarter of last year.

Okay.

All right.

And what would -- could you -- do you have the sales count for the first quarter of this year versus last year?

Sales count of?

Number of sales people.

You know we don't give out the details numbers of sales people.

We don't have that count updated.

How do you quantify the increase?

We track it here internally but we don't release the detailed numbers because we don't want to get into a breakdown of how our sales force is structured and tip our hand to the competition on how we are generating that internal growth.

Okay.

Fair enough.

And the gross profit in the rental side 46.1%, the highest, I think, the company has ever seen.

Tell me again, when you do the reclassification, does that go up or down?

That goes down by maybe 40-50 basis points.

Okay.

And have you seen any change in employee pay vs. employer pay in this economic environment for the rental side?

No, we haven't.

Still predominantly 70% of our customers, the employer pays 100%.

The remaining 30% with sharing with their employees.

Okay.

Thanks for the call.

Thank you.

Bill Creeby with Geneva Capital Management has our next question.

A quick question.

The debt to capital now is in the 30s.

Do you have some sort of a target, as high as you'll go in terms of leveraging the balance sheet? 31, I guess.

I would assume there's plenty of wherewithal including taking on more debt in taking on another acquisition given the stress in the industry, I'm sure there's plenty of options starting to pop-up you didn't see several years ago.

We talked about this to the rating agencies.

We probably don't want to get much beyond a 40% debt to cap leverage.

When we first did the Omni acquisition, we were around 34%.

We worked that down.

But that would be around our comfort level as not to get anything higher than the high 30s to no more than 40%.

And how about the second part in terms of the opportunities available?

I would say that there are certainly more opportunities today than there were a couple of years ago.

But, you know, I wouldn't say there's anything imminent.

A lot of discussions taking place but that always happens with us.

Okay, thank you.

And moving all we'll hear from David Reidel with Salomon Smith Barney.

A couple of questions if I can.

First you mentioned form your cash flow statement setting aside reserves for medical and pension expenses.

Can you quantify that or perhaps put it into perspective relative to the year ago?

The amount we funded in the first quarter was approximately $32 million, a bit higher than last year.

What that does is put it into what we call a VIVA trust and allows us to take a tax deduction as we fund that trust.

We've been doing that consistently for probably the last three-four years that I can recall.

Great.

Moving on to Cap Ex, can you talk about the impact of lowered Cap Ex rolling out of automation of facilities or R&D?

I don't think there's much impact there.

We continue to have a strong R&D group and looking at projects if they make sense economically, we will roll those out in the various facilities, the biggest component of the reduction in Cap Ex spending this year vs. prior years rests in two areas.

One is facilities.

Not building nearly as many, not opening nearly as many facilities this year as we did a few years ago.

Part of that is due to the fact we can utilize facilities that Omni is bringing to the table.

We are able to take advantage of avoiding Cap Ex there.

Also as I mentioned earlier, the equipment on a shutdown Omni facility, we are redeploying where it makes sense within our own organization.

We will continue to roll out projects that is have an economic payback and continuing to be aggressive there.

Can we move on to one other, my last question about the cultural fit with Omni.

Sounds like the sales fit was not as tight or smooth as you hoped.

What about the culture throughout the rest of the organization and the culture with their customer service and customers?

The sales people is not a cultural issue, that was more of a, you know productivity issue.

As far as cultural fit with their SSR or truck drivers, production people, some of the middle management has been very, very good.

Great.

Thank you, very much.

And our next question is a follow-up from Michael Snyder with Robert W. Baird.

Good morning.

Maybe you could give me more color on lost business rates.

Karen, I believe you said it was a shade under 7% for that quarter and that includes Omni?

That does.

Okay, and presumably lost business rates there are higher than the core business, so that implies actually on a sequential basis the core business, lost business rate improved materially.

Well I don't know about materially, but I would say it's somewhere between 6 and 7%.

It's probably gotta be around 6 to make that weighted average work, right?

It could.

We don't have the exact number, Michael, because it's difficult to break those things out.

I'm looking at the-sequential improvement from the lost business rate in the core business and maybe you could give us some color as to where you have seen the improvement.

Is it in the financial losses?

Or evenly split.

It's pretty evenly split.

Yeah.

We do track that.

We call that customer defections versus lost business.

It's evenly split.

Just like the shrinkage within existing accounts, it appears to have deccelerated.

We are seeing the same experience in the lost business rate coming down a bit as well.

And another question on Cap Ex, can you refresh us as to how many plants were built in fiscal '02 and now what the new guidance implies for fiscal '03?

About 7 facilities built last fiscal year and this $125 million has an estimate of three to four new facilities.

Being opened.

Yes, that's right.

Okay.

And another follow-up from Chris Gutech from Morgan Stanley.

Thanks, one more question, do you have the operating profit breakout between the rental and the other service businesses?

We do not have that yet because we want to wait for when the reclassification is done.

We will have that before we file the Q.

Okay.

And a big question, I know you guys have been looking at a number of new lines to get into and beta testing several, do you have any update at this point?

Chris, no, we are still beta testing a couple and at this point in time, we are not ready to disclose those publicly.

And I noticed the discussion in your annual report published regarding stock options.

We, if you read our chairman's letter in the annual report, you'll see exactly what our position is.

Due to the impossibility of how you value those things, we don't believe expensing stock options makes sense and we have no plans to do that.

And Amanda Tupper from JP Morgan has a follow-up.

I want to follow up on the new business mix, you said in your prepared remarks it's still coming more from competition than new programmers.

I wonder if you could elaborate on that mix.

We commented on that in the fourth quarter.

We didn't comment in the first because we don't have that breakdown.

We calculate that on an annual basis and we did make that comment in the fourth quarter analysis.

Okay.

Do you track it internally?

No, again we measure it once a year.

Okay.

Thanks.

And another follow-up from Bruce Simpson from W.M. Blare.

I'm sorry.

I don't know if I didn't hear it or you didn't say it, what is the reclassification reason, is it customary or specific to this quarter?

That's just specific to this quarter.

What happens is the beginning of the fiscal year, we often make a lot of changes in terms of location and how things flow together and as we were pulling the numbers together for this quarter, we realized that we had not properly classified a number of things.

This morning as we looked at the numbers, that's what prompted us to tell you they'll be slightly modified before we file here.

Okay.

Are you willing to give more detail about what it is that just to clear it up.

Just a matter of where you classify like a distribution center.

Where you take certain businesses are more direct sale and the cost, you have to make sure the cost follows where the revenue is.

This is not a material impact as we said before.

It's just going to adjust the rental business by 40-50 basis points and the cost of other services will be adjusted around 200 basis points.

Is this related to Omni?

No, nothing to do with that.

Okay.

And then shifting gears, the Sanis line, I wonder if that has begun to be rolled out to anybody else within the core Cintas family or too early?

It has begun to be rolled out on a test basis for some Cintas facilities.

We are testing that in various pieces right now.

And lastly we haven't talked about manufacturing at all in the call.

Is there anything at all that should be brought up to date in terms of where you stand with your various plants?

Not really.

Manufacturing continues to be conducted in 14 of our facilities.

We're, there's no change from where we were before.

Thanks.

And no further questions at this time.

I turn the call back over to you for additional or closing remarks.

Again, I want to thank everyone for joining us.

I am hoping it was an informative session for all of you.

We will look forward to speaking with you again in late December as we release our second quarter results.

And that concludes today's conference.

Thank you for your participation.