信達思 (CTAS) 2003 Q2 法說會逐字稿

Good day everyone, and welcome to the Cintas second quarter 2003 results conference call.

Today's call is being recorded.

At this time I'd 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 thank you for joining us today.

We are pleased to announce increased sales and profits for the quarter ending November 30th 2002.

Our Rental business grew at a rate of 21.7% Cintas acquired Omni Services in May of this year, and the revenue contribution from Omni was approximately $70 Million dollars in the quarter.

Excluding the impact of Omni, and the other acquisitions made in the last 12 months, our rental business grew approximately 4.5%.

Other service revenues, which consist primarily of direct sale items, increased 24%.

Many of our direct sale customers were seriously impacted by the events of September 11th 2001.

However, as we expected, these customers have begun to purchase uniforms again.

Net income increased 9.2% to a record $63.3 million, while earnings per share were $0.37 verses $0.34 last year.

We continue to be pleased with the Omni Integration.

Most of the integration activities are now complete and we should begin to see modest profit contribution from Omni in the second half of the year.

This is what we had indicated would happen when Omni was acquired.

Our focus has been to assimilate Omni into the Cintas Organization as rapidly as possible, and we believe we are slightly ahead of schedule.

Our Current guidance of revenues and earnings per share for the fiscal year ending May 31st 2003 remains unchanged.

That guidance calls for total revenues of $2.7 billion - $2.8 billion and diluted earnings per share of $1.55-$1.62.

The timing and extent of economic recovery coupled with acquisition opportunities, will impact the degree of eps growth.

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

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

The private securities litigation reform act of 1995 provides a safe harbor from civil litigation for forward looking statements.

This conference call contains forward looking statements that reflect the companies 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 discussion on these points contained in our most recently filed reports with the securities and exchange commission.

Now I would like to turn the call over to Karen Carnahan for more details.

Good morning, everyone.

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

We have updated our website with our second quarter financial results.

You may want to go to that section of our web site and have the financial statements in front of you as I explain those numbers.

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

I will first start by commenting on the income statement.

Total revenues were $681 million for the quarter, a 22% increase over that reported in the prior year.

This second quarter of fiscal 2003 had 65 workdays, which is the same number of workdays in the second quarter of last year.

So our numbers are comparable on an apples to apples basis this quarter.

The breakdown on those revenues is as follows.

Rental revenues were $526 million, compared to $433 million last year.

This was an increase of 22%.

Our internal growth rate, excluding acquisitions made in the past 12 months was about 4.5%.

The sluggish economy has not allowed us to make any headway, as witnessed by our organic growth rate of 4.5%.

Please recall that our organic growth in the first quarter was around 5%.

The slight decline in the organic growth does not carry any real significance, other than the fact that we didn't see any clear sign that the economy is getting any better.

Our growth rate in the uniform side of our business is definitely taking the brunt of this sluggish employment environment.

Manufacturing employment continues to decline, and although services employment seems to be growing at an anemic rate, we are not seeing any growth overall in our customers employment base.

The positive notes we can make are that the other rental services are growing and our new business continues to be very healthy.

Let me go into some further detail on sales performance for the rental side of our business for the quarter.

From the perspective of our existing customers we look at three factors when evaluating total revenues.

First a measurement of the change in customer billing, which we call "add-ons" verses stop orders.

In other words, when a customer hires a person, we call that an add on, and when they lay off or terminate a person, we call that a stop order.

We also quantify the amount of add ons or stop orders for our other rental products.

Including our entrance mats, shop towels, mops, and hygiene services.

Secondly, we look at price increases, and thirdly we look at lost business.

For the second quarter, our total add ons and stop orders were slightly negative in total.

Most of you will recall that this statistic has been trending negative for quite some time.

The fact that it is slightly negative causes us to be somewhat optimistic.

However, the only caution we take in getting too encouraged by this figure is that it reflects our ability to get additional revenue in the winter months by adding on jackets for our uniform wearers, and also an increase in usage of entrance mats which control tracked in snow and salt.

Unfortunately the statistic for our uniform business has not stabilized and the fact that stop orders continue to exceed add ons reflects the sluggishness in employment levels.

But the statistic is nicely positive for our facilities services business.

Our entrance mats mops and shop towels.

The other thing that hurts top line rental growth is the fact that when customers do not hire replacements for the people they terminate, then we do not have the ability to collect additional up front revenue for those new employees.

When a customer adds a new uniform wearer to his business, we charge the customer a fee for preparing the new uniforms for that person.

This is usually a nice amount of revenue.

But if the employer leaves that employment position open, and doesn't hire a person to fill the spot, then we cannot realize that additional revenue.

We believe that negatively impacted our revenue growth by about 2%.

Now let me address price increases.

This is a tough pricing environment. (inaudible) for two reasons.

Our customers are looking at their cost structure, and in the case of uniform rental services, we believe they are looking at it much more than in the past.

We believe that this reflective of just the overall business climate, and the fact that businesses are looking at every dime they spend.

The other reason the environment is tough is because our competition has sharpened their pencil on pricing, just like we have.

So price increases are virtually non-existent right now.

The amount of business that we lost clipped our top line growth by about 7.5%.

This turned a bit worse compared to the first quarter.

If we break down the lost business between Cintas business and Omni business, we see that we have lost about 7% of our base business and about 10% of the Omni business.

Before we leave the discussion on rental revenues, the largest component of growth to be addressed is new business.

With our 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.

Revenue from new customers continues to hit record levels.

We made a strategic decision to gain market share during this tough economic period, so we sharpened our pencils on writing new business and we got some new business that we otherwise would not have gotten.

So that explains what we saw in the second quarter, before we move on to the discussion about our other business services, many have asked us to reconcile the organic growth from the different business areas.

New business, lost business, price increases, etc.

In order to do that we have to go back over the last 4 quarters, pull these metrics, and extrapolate the figures to derive the second quarter's rental revenue.

The 4.5% organic growth in rental business can be broken down as follows.

New business caused our top line to grow by 16%.

Price increases added 1/2 of 1% lost business subtracted 7.5% from our growth.

The Add/stops statistics took off another 2.5%.

And our current inability to get one time revenue from customers subtracted another 2%.

Now we would like to move on to discuss our other services revenue.

Other services revenue increased 24.2% over last year.

The second quarter of last year was a tough year for this segment of our business.

This segment includes the sale of uniforms to hotels and airlines.

The majority of these companies dramatically cut their purchasing programs after September 11th.

Now one year later we are starting to see an increase in the demand for new uniforms.

Excluding acquisitions uniform sales grew by approximately 15%.

Our other services revenue also includes the first aid and safety business and the sale of disposable products in our cleanroom business.

Both of these divisions experienced high single digit organic growth.

In total our second quarter revenue of $681 million increased 22%.

Organic growth without acquisitions was 6%.

Now let me address the margins.

Our rental margins were 43.9%, representing a 190 basis point decline from last year.

Our material costs have increased due to the tremendous amount of new business being written.

In the past several months, our material cost percentage had dropped as we more effectively used our stockroom of used inventory.

As customers reduced their employment base and used garments are returned to us, we are able to reduce our material costs by recycling that used inventory more effectively.

Although we continue to do this the benefits of that is being offset by the increased material costs of all the new business being written.

So far this year our new business is 24% higher than it was in the first six months of last year, and this growth is very expensive.

Due to the fact that customers receive brand new uniforms.

These increased material costs reduced our margins by approximately 60 basis points when compared to last years margins.

The majority of the decline in margins is due to our decision to accelerate the integration of the Omni acquisition.

To date we have closed the 46 rental locations, 11 plants, and 35 branches.

In addition to Omni's Atlanta call center and their two uniform distribution centers, so the integration of Omni's business has for the most part been accomplished in six months which is record time for our company.

A good comparison would be our integration of the Unitog acquisition which we made in 1999 which took a little over one year to integrate.

What we learned from Unitog was that integrations should be done as soon as possible.

The faster the better.

So with that said, we set a goal to get the Omni integration done by December 31 and we accomplished that goal.

A big piece of this integration was the conversion of the remaining 30 Omni rental locations to Cintas' computer systems.

In converting Omni over to our systems, we hired extra personnel and paid overtime to transfer their entire database over to our system.

We had a dedicated task force from Cintas who went into each Omni operation and trained them on every aspect of our system.

This also included installing and training the service sales representatives on our portable route computers so they can service our new customers more efficiently.

This conversion was completed by mid-November.

The former Omni operations now serve their customers from our AS 400 system.

All the billing and customer service systems are tied into this new system.

In addition, those former Omni locations are now tied into our distribution centers so they can efficiently place orders for new uniforms.

We are also seeing many of the former Omni customers being converted to our product line which will temporarily hurt our material cost percentage.

So, with the integration of Omni substantially behind us, we can make some head way in improving their margins.

Now let me address the other services revenue margins.

These margins were 34% compared to 29% last year and 31.9% in the first quarter.

These margins have improved dramatically as our business has picked up and absorbed the fixed cost of our manufacturing plants and distribution centers.

With the acquisition of business from Angelica and forwarding the majority of that business into our Chicago distribution center, this acquisition also helped to offset the fixed cost of running that facility.

Our selling and administrative expenses were 25.8% of revenue and 60 basis points higher than last year due primarily to an increase of sales people, sales promotions and advertising.

Again, as long as we continue to experience success in writing new business, we will continue to aggressively grow the sales force and capture an increase in market share.

Our administrative costs also include the amortization of acquisition costs.

With the Omni acquisition we have an additional $2.5 million a quarter in amortization expense.

The rest of our administrative costs have declined as a percentage of revenue due to the growth in the top line without any measurable increase in overhead to support the growth.

The Omni headquarters operation in Culpepper which used to employ 170 people currently has nine people working there who are winding down the computer and pay roll systems.

The Omni people will go on Cintas's pay roll system on January 1st.

The headquarters operation will be completely closed approximately January 31st.

That interest cost 1.1% of revenues compared to previous years .3% reflecting the interest from the financing of the Omni acquisition.

The good news about interest expense is that our average interest rate is hovering around 4 3/4% and as mentioned in the press release, we reduced our outstanding commercial paper debt by $125 million which was 55% of the peak amount we had borrowed last may.

Our effective tax rate was 37%, the same as last year.

So for the quarter, net income was $63 million and that compares to 58 million last year.

Earnings per share increased 9% to $0.37 per diluted share.

Now let me look at the cash flow statement and give you a few items of note there.

Capital expenditures for the quarter were approximately $30 million.

Total capital expenditures for the year will continue to be lower than in the past as long as the economy rate remains weak.

We are adding approximately seven new operations in markets where growth is exceeding capacity.

For the year we still expect capital expenditures to be approximately $110 million.

Cash flow was strong for the quarter with $112 million being generated from operations.

After prefunding, our VIBA trust for medical expenses in the first quarter, that is behind us and cash will build from this point forward.

Also, in the income tax area, we are using some planning initiatives to conserve cash similar to last year and the majority of our tax payments will be deferred until the latter part of the fiscal year.

To address the balance sheet, we would make the following observations.

Accounts receivable is up from last quarter and up 14% year over year.

Excluding the receivables from the Omni acquisition, our accounts receivable is flat compared to last year.

Our DSO of 40 days is comparable to prior periods.

New goods inventory is up 10% over last year, reflecting the uptick in orders of national account sales division.

Our in-service inventory is up 18% reflecting the amount of new business being written in the rental group.

In conclusion, our business is on solid ground.

Our rental business is growing in a tough economic climate and that growth is extensive because of the new garments being purchased for these new customers.

When we start experiencing growth, within our existing customers, our profitability will improve.

At the same time our profits have been able to absorb a lot of one-time integration costs for the Omni business which for the most part are behind us.

And lastly, it is good to see some of the pentup demand coming our way in the uniform sales side of our business.

Before we turn the call over to questions, we wanted to alert you to the fact that the government just released the updated numbers on our industry.

The uniform and textile industry grew 4.7% to $9.75 billion in 2001.

The industrial laundry sector within that industry grew 4.4% to $6.3 billion.

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 do so by pressing the star key followed by the digit 1 on your touch tone telephone.

If you are using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment.

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

Once again, please press star 1 to ask your question.

We'll pause for just a moment.

Our first question comes from Adam Waldo of Lehman.

Ah yes, good morning Adam Waldo, Lehman Brothers, How are you Bill and Karen?

Very good, Adam.

Happy new year coming to you.

A few questions on Omni, if I may.

Can you give us a sense for what you think the revenue atrophy or attrition from that is over this point realizing that you are sort of achieving record speed in integrating facilities and reducing head count but continuing I think to have challenges on revenue retention?

Adam, I would say the bulk of the attrition should be completed notwithstanding further deterioration or sluggishness in the economy.

I think, you know, the problem we run into when we do an acquisition, we start the integration processes that we are rerouting or applying new service representatives to customers.

Customers that, you know, a business we really don't want and I would sa most of that is behind us because we have pretty much completed the integration.

However, Omni customers are very similar to Cintas customers.

Until we start seeing better pickup in the sectors, obviously still vulnerability of additional shrinkage in existing accounts.

Would it be fair to say you didn't see serial sequential change at automatically in the November quarter and largely have the existing client base under new contracts on the rental side attributable to the Cintas parent?

The answer to the first question is yes.

The answer to the second question is because Omni was good at having their customers under contract, I would say that we have not had to go in and sign up a bunch of their customers under contract, under the Cintas contract similar to ours.

So what we are typically doing is we're renewing their contracts with the Cintas version as they get close to the anniversary day.

Okay.

And then one last question on Omni, any adjustments to the Omni closing balance sheet in mid-May during the most recent quarter?

No, we have not made any adjustments.

We are tracking them as we go.

There's been some minor firming up of some numbers but nothing material.

What we intend to do is once we get through the one-year anniversary, we will obviously communicate to the analyst community and investing community any material changes in the balance sheet reflected after the one-year anniversary.

Ok, fair enough.

One last question if I may.

Did you have any ability to quantify for us the one-time incremental integration expenses to which Karen alluded to qualitatively in her prepared remarks during the quarter?

Adam, we did not.

We did not make the effort to accumulate all that stuff separately because we have so many different Cintas groups that are working on that both in operations as well as in all the staff departments and didn't feel it was -- it added any value.

It obviously was in the millions, over a couple million dollars but I do not have the exactly quantitification.

Ok, thanks.

And we'll take our next question from Michael Snyder of Robert Baird.

Good morning, I wonder if you could address the profitability issue again.

Karen, you mentioned that as volumes come back within the existing accounts, that will help overhead absorbsion and fuel some margin expansion.

The issue I'm wrestling with, though, is the model in this industry is built that when growth accelerates margins actually decline.

In a market like this, margins actually expand.

What you're laying out, I guess, is the hope that as stops improve, margins will expand from here and that is counter to what history has taught us in this industry.

Maybe you could shed light on that.

I think the difficulty we are having in explaining why margins would go down with a 4.5% internal growth rate is because the new business success and what we're experiencing in topline growth from new business which I quantified to be around 16%, so much of that is being offset by lost business and the add/stops and the fact we are not getting that additional revenue in makeup charges and prep charges for putting uniforms onto those replacement employees because they are not being replaced.

So that is -- we've got a successful new business effort.

It's bringing us in a healthy amount of new business which is very expensive.

At the same time we've lost 7.5% of our business.

We've got shrinkage in our existing accounts and that is very profitable business that we are losing.

And that dynamic that's going on there, Michael, is what has temporarily hurt our margins.

Is it a case that during this recession, you've just been extraordinarily aggressive on the new account growth, certainly more so than past recessions and that has changed this margin model?

That is absolutely true.

Okay.

My concerns of profitability moving on to the next question really relate to pricing.

In talking with a wealth of small private companies and medium-sized private companies, they acknowledge what you laid out which is pricing is extraordinarily competitive especially in new business.

In what used to be a model of 1.30 change in day, I've heard prices as low as $0.59, $0.61 a day and it strikes me that your number of plus .5% during the quarter for price seems to be difficult to reconcile with what I hear is going on with new customer quotes.

Maybe you could shed light on that as well.

Half a percent doesn't jive with what you are hearing?

Exactly.

The half percent actually is looking at the last four quarters of price increases and then equating that how it comes into the topline growth in the rental side of our business in this second quarter compared to the second quarter of last year.

So that's the analysis that I gave is trying to reconcile the 4.5% organic growth from this November to the last November which obviously you have to look at all those metrics in the last four quarters.

So any price increase looking over the past twelve months is likely coming from the existing contracts and the inflation adjustments you're making there?

That's right.

Are those trending down the ability to raise price on existing accounts?

As this number has trailed off over several quarters, it's probably even flat to negative now?

I don't think it's turned negative yet but that is closely tracked to CPI.

As the trend of CPI has gone down, so have price increases of the anniversary date of the existing contracts.

But presumably, the price competitive acceleration or increase of this industry has also even caused you to take less than CPI at this point?

And especially evidenced when we renew a contract.

Right, ok.

Thank you.

We'll take our next question from Greg Capelli of Credit Suisse First Boston.

Hi good morning, it's Greg & Clayton.

Good morning.

I wanted to follow on to that a bit.

Because you've been more aggressive on the new business front and willing to give you up price to get it, is it something that you're concerned at all is reversable going forward or do you think as things strengthen in the broader market and economy it will take care of itself.

Greg, I would say it's going to change as the economy strengthens.

I think pricing power will come back in.

We are not concerned about that.

We felt it was good for us from a strategic standpoint to be aggressive on this new business to meet the competition.

As a result of that, I think that is reflected in our good result of new business.

But I think that as the economy strengthens, you'll see that improve.

Bill, could you talk more about your expectation for the rental gross margin in the back half of the year?

Sounds like you are expecting it to get better.

Wonder if you could put more color around that.

I think it is going to get better.

The reason is because embedded in the costs that created the margin where we are at are a lot of these costs associated with the integration of the Omni facilities and all the associated costs, retagging garments and rerouting and training people, et cetera.

I think there's going to be an improvement as we go forward there.

I think the other thing that's going to happen is that we hope to see improvement among our existing customers with regard to less shrinkage and I think as a result of that we should see some improvement.

The facilities will start to fill up more so we'll get some of the synergies associated with more utilization and more capacity and I think we're also going to continue to be aggressive on adding other products and services to existing uniform customers which as we've always talked about is more profitable and that will come along again as the economy also strengthens.

All those factors will help us improve the margins going forward.

Okay, I understand.

Just one final question.

I'm assuming your longer term goal is still to achieve 15% internal and 20% total growth and I wanted to get an idea of the acquisition landscape and pricing for acquisitions at this point and if you remain as aggressive at this time, what acquisitions are planned to going into calendar '03 here?

I would say that our growth objectives remain unchanged.

With a normal economy.

That certainly we believe is achievable going forward.

As far as the acquisition front, you can see that we really didn't make a lot of acquisitions in the second quarter.

We have not seen any substantial change in pricing.

Nor have we really seen a willingness on the part many of our small and medium-sized companies to consider selling their businesses which to us is a bullish statement on the industry that these people are still able to achieve the results they want to achieve.

Now, with that said, we are still being very aggressive in talking to perspective acquisition candidates.

We still believe that over time, some of these people will for various reasons decide to sell their businesses.

Again, we expect them in many cases to consider Cintas as the buyer of choice because of our ability to structure a deal in many different ways to meet their personal requirements.

So the economy has not really had an impact on forcing people to want to sell, and we really haven't seen any substantial change in price.

Okay.

Thanks, very much.

And Chris Guteck of Morgan Stanley has our next question.

Thanks.

Good morning, Karen & Bill.

A follow-up question similar to the previous question, I don't want to beat a dead horse here but the issue of pricing does seem to be very important.

I guess if I do some back of the envelope calclulations, it seems as if you're still getting positive CPI-type growth for your existing business.

That must imply the price you are getting for the new business just written is probably down somewhere between 5-10% on a year-over-over business.

Does that sound about right?

Chris, it's hard to say.

There are just anecdotal stories about the pricing on new accounts that we can impart and I don't know we have an overall calculation or statistic that we can give you to verify that.

Okay.

And I'm sure you guys are aware that Aramark, obviously one of your direct competitors has talked about trying to accelerate the organic growth going forward.

And so when you guys talk about trying to take market share, I'm curious, are you trying to take it from larger competititors which would be a difficult thing to achieve if your all trying to do the same thing or by contrast if you are really agressively going after the small mom and pops who may have a competitive disadvantage.

You know Chris, we wouldn't make a statement that we are targeting any group of competitors at all.

We're -- we just want to grow.

Our sales force, they understand the mission in growing our business.

They understand the opportunity that they have right now to grow market share in this tough economic climate.

They are going after accounts like they have in the past.

Still targeting no-programmers.

In fact, in the current quarter half of our business came from no-programmers.

About 45% came from competition.

But we are not targeting any specific group of competitors.

Okay.

And a follow-up on Omni integration.

The good news is that the integration is ahead of schedule.

Because that's the case, have you guys re-evaluated your expectations for the long term cost savings or ultimately what the earnings per share accretion could be once business is fully integrated?

We really haven't done anything differently from what we signaled before, Chris.

I would say when we get into our budgeting cycle here in the April time frame, we'll be looking at that a lot harder in terms of what might happen in the future years.

We still believe that for this year, we signaled that we expected a contribution from Omni of 3-4› a share for the full physical year.

A lot of that in the latter half of the year.

We still believe that that is the case.

Obviously I'd love to have some positive surprises but I'm not willing to commit to anything at that point.

Finally a follow-up to Adam's question, the good will was up by 10 million but doesn't appear any acquisitions made in the quarter.

I heard you say there were no changes in the balance sheet for Omni.

I was assuming the only explanation for the increase in the goodwill would have been a writeoff in the reserve, there, is that not the case?

It would have been a tweaking of the Omni balance sheet coupled with a couple of other things, Angelica etc. that might have happened during the quarter.

I don't have a specific answers.

It would certainly be something along those lines.

I think the reserve for Omni was something like $36 million.

I think as of the last call only $5 million of that has been paid in cash.

Roughly the same number.

That's the payout of the severance.

Moving on.

The next question from Bruce Simpson of William Blair and company.

Good morning, Bill and Karen.

Good morning.

Strikes me that in order to be able to hit the guidance targets for the full year that you've laid out, we're going to need to see either accelerated revenue growth or improvement in gross margin.

I wonder if you can lay out in your mind how much of the improvement in the second half of gross margin profitability overall comes from the process you are moving into the later innings of the Omni integration and that's going to start to pay dividends versus how much of it comes from a little bit better economy driving revenue growth and so forth.

Bruce, that's tough to nail down especially on the question about the economy.

I would say roughly from a margin improvement and getting Omni out of the way is between 100-130 basis point improvement in gross margin.

That is what you might anticipate between today and your fourth quarter result, is that what you're saying?

No, that would be the comparison of the impact on margins in the second quarter compared to what it would be in the second half of the year.

Okay.

So just to make sure I'm not missing the point.

The gross margin for this quarter was 41.7%.

Right.

So is what you're saying maybe between 42.7 and 43 entirely is what you might expect it to return to now that you should have some tail wind from Omni?

That's a rough estimate, Bruce.

Again, not being able to quantify the impact of anything that changes in the economic assumptions and the impact on rental growth in the second half.

Okay.

But that's the Omni piece alone rather than any change to the economic assumption.

Yes.

That's my best estimate.

Okay.

And then taking that same kind of analysis and looking back into its impact for this quarter, it looks like the gross margin number went down from your first quarter about 70 basis points in total.

Obviously, that's blended between a significant increase in the sales component of the business and a decrease in the other part.

Is it possible to say okay, of that 70 basis point, either X basis points or percentage probably came from the impact of higher garment costs because of the new business written versus what portion of it came from additional expenses from Omni.

Well, again, a portion of it does come from material cost but the vast majority does come from Omni.

The best thing to do is really just look at the margins, separate the two margins and not combine them with the other service revenue fees.

So the sequential drop in rental margin is substantially Omni.

But a small piece is the material cost.

Okay.

And the last thing I have, Karen, is I guess I'm curious why we had this noticeable of an impact in the Nov. quarter but not the August quarter.

I thought that Omni gave us a whole revenue contribution in August.

Does that imply there were a lot of activities that were expensive in terms of the integration that didn't begin until the November quarter?

Yeah, that is exactly right.

A definite move to accelerate it to get it done and out of the way.

I think we even signaled that the computer conversion was going to be done by December 31, well we actually completed it November 15th.

We applied a lot of labor in order to get that done.

We designated task forces that went out and traveled to each of the Omni locations.

We paid a lot of overtime to the people in the operations to get it done.

Basically what we've said was this has got to get done and out of the way in order to start realizing the synergies of the acquisition.

They can't order uniforms from our distribution center or convert to our product line until all that gets converted.

So there was a definite strategic decision made to get this done ASAP.

Great.

I'm sorry.

I implied that that was my last question.

I thought of one more and that is I tried to model forward the seasonality of the sales business.

Obviously had a noticeable step up and I know the November and May quarters are typically the strongest and I'm wondering.

Though you don't break out guidance in revenue between the two segments of the business, should we be thinking that we are probably seeing the beginnings of a fairly sustainable increase in the other services part of revenue because that part of your customer base is starting to feel stronger?

Or is it primarily because, you know, the change in seasons brings a good second and fourth quarter.

Well, I think it's both.

We are going to see -- you're right, Bruce, our second and fourth quarter usually are always the strongest and the third quarter can be a little weak in direct sale.

We are comparing to low easy comps from last year.

So, you're going to still see improvement.

The other thing that impacts that line item, too, is roll-outs.

We've mentioned time and time again that in the direct sale business, it is a much more volatile line item than you'll see in rental because you'll have a big customer decide to do a roll-out at a particular time of the year.

So it's harder to predict that because even when they say they're going to roll out something in February, due to their internal problems, they may not be able to start it until March.

We don't want to give specific guidance by quarter.

Well, we don't to it at all but especially when it comes to the direct sale business.

There's too many factor that is impact that.

Thank you both.

And Kevin Monroe of Thomas Weisel Partners has our next question.

Morning.

Good morning.

I'll ask a question on pricing again.

You guys obviously kind of a double impact.

Your new business pricing is lower and your getting hit with lower margins from manufacturing new uniforms.

What is your discipline, basically how low will you go on margins to gain share?

I don't think there's a hard and fast rule, Kevin.

It is really a situation that is looked at on a customer by customer region by region basis.

Do you have any data on what the EBITDA or even gross margin is on the new business you're bringing in?

I am not in a position to share that information with you.

Okay.

And one more question on the Omni acquisition.

I know you kind of mentioned now that the integration is complete, going forward and excluding any significant change in the economy, you'd kind of expect the attrition in the business to be stable, but do you expect it to accelerate, I mean to make your 290-300 million target for the year, you need an uptick in the revenue there and can you do that in light of the force the sales force on that side of the business is smaller than originally anticipated?

Actually, Kevin, our estimate is not $280 million for Omni for the year.

It's $70 million a quarter.

That was what we saw in the first quarter and the number we saw in the second quarter and both the same number of workdays.

Definitely has stabilized.

There might be a little bit of an uptick in Omni.

But I would not predict it at this point.

I'm not very bullish on the economy accelerating at any great extent here in the next six months.

I'm not expecting any real further deterioration, either.

I certainly doesn't seem to me from looking at the employment figures that we're going to see a real rampup here.

I would guess that we will be probably at the lower end of those ranges because of our expectation of the economy.

Okay.

Thank you.

Jim Haggerty of Bartlett & Company has our next question.

Hi, Bill and Karen.

Hello!

A question from a local yokel.

Karen, in your reconciliation of the rental, the various internal new pricing etc. you mention loss at 7%.

7.5.

Can you give us a historical perspective?

How does that stack up, not verses last quarter or the year before but what's been your experience over the last five or ten years?

Definitely it's been in the range of 4-6%.

So a little higher.

Second thing, you used to share a statistic when you talked about new business growth as to the percentage of it that came from first-time users.

How is that tracking?

Well, actually last year, fiscal year '02, about 53% came from first-time users. 47% from competition.

We are trying to track that now every quarter.

We used to only track that only once a year.

We are trying to get our hands around that every quarter.

And it appears that in the second we were around 55% for no-programmers and 45% for the competition.

And the third and final question, your outlook for acquisitions, do you still consider yourself in your outlet primarily a domestic company or do you find yourself evaluating opportunities, for instance in Europe as you consider acquisitions?

We have a limited interest in Europe.

We are monitoring what's going on over there.

We know the players, but I would say that chances of us entering Europe in the near term are slim.

Is there something about it, Bill, that's inherently less attractive than the U.S. and not as good a business over there?

There are many factors.

I could go on for quite a long time.

Just to summarize some of the major factors, one is we have no presence in Europe today; therefore, we have no infrastructure, no distribution centers or route system.

That's one.

Secondly, Europe, while they certainly have made strides to become a more unified group, they are still separate countries with separate cultures.

You don't have the flexibility of moving people from one country to another so that becomes a difficult factor.

And third, I would tell you that the business, the industry itself is not -- I don't want -- advance is a bad term but it isn't the same.

Many of the garments worn by uniform wearers in Europe are more of overgarments like coveralls as opposed to shirt and pants.

There's not the -- I guess the practice of having a clean shirt and clean pants every day supplied by a uniform company.

Is that because they are not marketing it correctly or because it's a cultural thing, we don't know the answer to that.

Other factors, obviously, more currency exposure, the difficulty of managing from here, all those things together kind of keep us not very hungry to enter Europe in any way in the foreseeable future.

I asked the question only because as I look at what your company has done in five years and look out the next five or ten, it would seem you've swallowed a couple of biggies in Unitog and now Omni and the question is, now you're tracking along close to 3 billion in revenues, are there ample enough opportunities?

Yes, there are ample opportunities, we feel very good about that, I think more excitingly are the organic growth possibilities which are what we really like.

With the market potential being still about three times the current surf market, we believe that our marketing strategies are correct in pursuing no programmers.

We continue to see even in the weak economy the ability to sell to people who never had our services before.

Therefore that is going to be a key component of our growth going forward.

But I think there will be more Omni type companies that will become available over the next three or four years.

I think Cintas has demonstrated that if it is a good company that we will be very aggressive in pursuing acquiring those companies.

We have an opportunity group continuing to look at the possibilities.

What's your outlook over the next year in terms of growth of your sales force?

We will grow our sales force at a rate necessary in order to provide the right amount of new business that we feel we can get.

Can you put a percentage on that?

No.

We don't do that, Jim, We believe that that's strictly an internal thing that we don't want to signal to our competitors what we will do but we will continue to be aggressive in making sure we have enough sales people to create the amount of new business that we need to have.

Well, please keep up the good work.

Thank you.

Next we'll go to Bill Prevy of Geneva Capital Management.

By the way, great job in a very, very tough environment.

What about auxiliary services.

Obviously, the mats, the air fresheners, you covered quite a bit of ground in the last five or six years, is there anything you care to share with us as far as future opportunities.

I'd like to share one thing and that is the fact that our CEO, Bob Kohlhepp, is very bullish on that going forward and he has pretty much motivated the rest of the company in that area.

I was on a route ride which is something we in management have to do every year where we go out and spend time with one of our service sales representatives and I did one of those earlier this week.

And it astounds me the opportunities that still exist out there not only in our uniform business but the ancillary product business with the entrance mats and the other hygiene services.

I would tell you we are very bullish on the opportunities going forward.

And we have been very aggressive, I think, in developing new products, new techniques, targeting different types of customers than we have in the past in promoting these types of products.

It is going to be a big help in achieving our growth objectives.

Thank you. 1

We'll take our next question from Greg Holter of LJR Great lakes Riedies.

Good morning, Karen and Bill.

Good morning.

On the last call you had talked about getting your SG&A closer to a 25.5% of sales level by the end of the year.

Is that still on track or somewhat better given the Omni situation?

I want to say it might be better but it's certain on track.

That's an area that Cintas, I think, is very aggressive in making sure we don't let overhead creep into our company, and it's a closely monitored number especially on the G&A side.

I would say that the target that we gave you last quarter is still achievable.

Okay.

And, Karen, I missed the numbers that you stated on the different inventory areas.

Can you repeat those?

On the balance sheet, Greg?

Yes.

New goods and so forth.

The new goods inventory's up 10% over last year and that is a reflection of the orders in to the national account sales division in Chicago and the in-service inventory which is for the rental group is up about 18%.

Okay.

And, finally, there was some discussion about new products or areas where you would be looking at getting the internal growth.

Can you spell out some of those areas in more detail?

Well, what Bill was talking about was the expansion of our business in the ancillary service area like the entrance mats and hygiene services like we offer today and how we are making strides in specializing in certain entrance mats and anti-fatigue mats and other types of mats that are designed and marketed to specific niches.

We really didn't tip our hand about any other new products and services.

Okay.

Thanks.

And we do have a follow-up question from Adam Waldo.

Hi, Bill and Karen.

A couple of follow-up questions and thanks for the comprehensive discussion today.

I wonder if you can just for a second, Bill, give us a little bit of thinking at the board level around dividend policy as you potentially consider congress potentially eliminating the double taxation of dividends in 2003.

Has that become a material issue for the board at this point?

Adam, first off, I can't comment on items that are discussed at the board level because I'm not in that board meeting.

Understood.

I would say that, a prudant company will be looking at that.

But, we still consider ourselves a growth company.

As such we believe that we can do better for the shareholders by continuing to fund additional growth within the company.

Okay.

You've talked periodically over the last several years about continuing makeshift toward offshore garment sourcing.

I wonder if you can give a rough sense what percentage of your garments for the rental business and direct sale business are being sourced through captive capacity onshore vs. offshore.

Adam, I don't know that there's been a dramatic change just in the last two quarters but where we stand today is that approximately 70% of our uniforms are manufactured outside the U.S. and 30% are still manufactured in the U.S.

okay.

And then lastly I'll take one more chance on this, any chance we can get your (inadible) EBITDA figures for the quarter before the 10-K filing?

No, Adam, we can't.

That's just -- Especially now with the holidays.

We are giving some of our accounting people time off and have all that in our 10-Q that we file in mid January.

Fair enough, I'll look then.

Thanks.

Thank you.

And our last question which is a follow-up from Michael Snyder.

Hi.

Just real quickly, could you give us a percentage of the sales force that you have retained out of Omni.

You indicated 225% but anecdotally again it sounds like that number might be lower in actuality?

I don't think it's lower, Michael.

I think it's still around that level.

I'm not aware of any significant change from what we reported last time.

Right.

And secondly on the pricing issue, someone has indicated earlier asking about how low you will go on new pricing.

I'm wondering if the rule in place for each of the GMs has been waived in terms of their mix between profitability and growth as a result of efforts to gain share?

No, we have not changed our benchmark for the mark of excellence for our general managers is still what we call rule 35.

That is a combination of their topline growth and their prefederal income tax margin.

Those two added together equaling 35 or above is still the mark of excellence.

We have not changed that.

So, how have you encouraged them to sacrifice margin to get the topline growth?

Was there a different compensation plan put in place this year?

No.

There's not a different compensation plan.

The margin primarily that you're seeing deteriorate in the second quarter is the Omni integration.

Right.

Now, there is some like we commented, there is some increase costs for material costs and in order to generate this growth, but we feel that that is going to be paid off in the long-term.

Right.

And we are long-term in nature and they are reviewed at the end of each fiscal year.

With new business though up 24% first half over last year's first half, it's a meaningful amount of business coming in at the lower margin, correct?

Well, assuming that it's sold, all sold at lower prices, it is an additional amount of business, yeah.

Okay.

But, Michael, again, we can't make a statement.

We don't have a statistic overall on what price that 24% increase in new business is coming on at.

Okay.

Thanks again and congratulations on a good performance in a tough market.

Thank you.

And that concludes our question-and-answer session.

I will turn the conference over to you, Mr. Gale.

I'd like to thank everyone for participating into today's call.

On behalf of all of us at Cintas I'd like to wish all of you a joyous holiday in 2003 and look forward to speaking with you again in March when we announce our third quarter.

And that concludes today's conference.

We thank you for your precipitation. -- participation.