信達思 (CTAS) 2006 Q1 法說會逐字稿

Good day everyone and welcome to the Cintas first quarter results conference call.

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.

Hello, and thank you for being with us this evening.

Joining me as usual is Karen Carnahan, Cintas' Vice President and Treasurer.

We are pleased to announce that revenue increased 10.4% to $823.5 million, and net income increased 9.5% to $79.5 million for the quarter.

Earnings per share grew approximately 12% to $0.47 per diluted share.

Gross margins have improved to 43.2% in the current quarter versus 42.7% in last year's first quarter despite increased energy costs.

Improvements occurred in the cost of materials and in service and in production costs.

Our current guidance of revenues and earnings per share for the fiscal year ending May 31, 2006, remains unchanged, and calls for total revenues of 3.35 billion to $3.45 billion, and diluted earnings per share of $1.95 to $2.05.

However, as mentioned in our release, we believe that the impact of hurricane Katrina, as well as higher energy costs, could move us to the low end of our earnings per share range.

While damage to our facilities appears at this point to be minimal, the impact on our employees and customers in the affected areas continues to be a major concern to Cintas.

All of our facilities in the affected areas have reopened, and are servicing customers to the extent possible.

We are providing assistance to our employees through continuation of salaries and benefits as well as providing other financial assistance as needed.

Several of our employees who are unable to return to their homes are working at other Cintas operations throughout the country.

Additionally, we are seeing a tremendous outpouring of support from fellow Cintas employees.

The Company did continue to purchase its stock in the open market during our first quarter as authorized by our Board of Directors last spring.

To date, we have purchased approximately 4.4 million shares of which approximately 4.1 million shares settled by August 31.

The Company has purchased approximately 35% of the $500 million authorized amount.

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 Company's current views as to future events and financial performance.

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

I refer you to the discussion on these points contained in our most recent filings with the SEC.

I will now turn the call over to Karen who will discuss this quarter's results in more detail.

We will then be happy to answer your questions.

Good evening.

Let me start with the income statement first.

Total revenues were 823.5 million for the quarter, a 10.4% increase over that reported in the prior year.

In this quarter we had 66 workdays, the same number of workdays as in the first quarter of fiscal 2005 and the same number of workdays on a sequential basis from the fourth quarter of fiscal 2005.

For modeling purposes, you may be interested in factoring in the number of workdays by quarter which are as follows.

For this first quarter we had 66 days, in the second quarter 65 days, in the third quarter we'll have 64 days, and in the fourth quarter we'll have 66 days.

This work-day breakdown by quarter is exactly the same as the breakdown last fiscal year.

Rental revenues were 628 million compared to 581.7 million last year.

This was an increase of 8% over the first quarter of last fiscal year.

Acquisition volume accounted for roughly 2.5 million of contributed sales in this first quarter for those acquisitions that have been made over the past 12 months.

During the quarter, hurricane Katrina caused us to lose roughly $600,000 of revenue in the rental operations.

We will talk more about the impact that Katrina has had on our company in a few minutes.

Excluding acquisitions and the impact of Katrina, our rental organic growth rate was approximately 7.7%.

I will go through some additional metrics behind this organic growth rate figure.

Our new business which has been booked over the past four quarters contributed 14% growth in our top-line rental revenue this quarter versus the same quarter a year ago.

This rate of growth continues to improve each quarter and, in fact, is a full 100 basis points of improvement over last year's first quarter new business growth of 13%.

The improvement in new business reflects the improvements in sales productivity that we have made over the last 12 months, while at the same time increasing the total number of salespeople in our rental operations.

Price increases to our existing customers contributed 1.6% in growth during the quarter which is a 60-basis-point improvement over the first quarter of last fiscal year and it's comparable to the fourth quarter of fiscal 2005.

Our contracts provide for annual price increases of the higher of CPI or 5% at the discretion of our managers.

Add-ons and stop orders reduced top-line growth by 6/10ths of 1%.

This measurement takes into consideration the increase or decrease in our business within our existing customer accounts over the past 12 months.

This figure is slightly better compared to our statistic for the first quarter of last year which was a negative 8/10ths of 1% but not as good as what we experienced in the fourth quarter, which was negative 1/10th of 1%.

We believe this is more seasonal in nature as some customers do cut back on services during the summer months.

This is especially seen in customers who do not use as many facility services products, like our entrance mats, during the summer months.

School systems would be an example of where we suspend the service for approximately three months until the schools are back in session.

When we look at the number of add stops in terms of uniform wearers we would note that it is not a positive figure as we had seen during the month of May, but it appears more sluggish than anything.

In other words, the numbers are slightly negative but much better than what we had seen during the first quarter of last fiscal year.

We would note that today a full one-third of Cintas' total revenue comes from facility services.

Uniform rental services now account for approximately 43% of our total company revenues, so our mix of rental business continues to evolve as we offer a broader array of rental products and service and for that matter, many other services which we will discuss in a few minutes.

Now lost business over the past 12 months clipped our top-line growth by about 7.3%, which is comparable to our fourth quarter performance.

So let me reconcile our total organic rental growth of 7.7%, new business added 14%, price increases added 1.6%, lost business subtracted 7.3%, and add stops subtracted 6/10ths of 1%.

I would remind you that all of these metrics reconcile the increase in rental revenue for the current quarter compared to the same quarter a year ago on a comparable workday basis.

The metrics capture the cumulative effect of all of the new business, lost business, price increases, and add/stops over the past 12 months.

Now, let me address other services revenue, which was $195.5 million, which increased 19% from last year.

On an organic, same work-day basis, this segment of our business grew 11.4% without the benefit of acquisitions.

This organic growth rate is double the growth rate that we posted in the fourth quarter of fiscal '05, which was 5.7%.

This segment includes the sale of uniforms to national account customers, the sale of uniforms through our catalog to our local customers, those who primarily rent products from us, the first aid and safety division, and the document management division.

First, our uniform sales business from our national account sales division and our catalog division in total increased over 11% on an organic basis, compared to a fourth quarter increase of only 3%.

We discussed the momentum in this business last quarter and we continue to see strength in the healthcare, hospitality and gaming sectors in our national account sales division.

In addition, our success in marketing and selling promotional products through this division has gained momentum as well.

Over half the promotional product industry sales are wearables, such as golf shirts, jackets, and hats.

And these are products we offer in our core product line that we efficiently provide for our customers.

At the same time, we have the systems to service the customers' needs in other promotional items, Cintas is now a one-source solution for uniforms and promotional products for these national customers.

The first aid and safety business grew 24% during the quarter and 10% on an organic basis.

The core first aid and safety business is seeing some nice momentum in organic growth, and at the same time the integration of our new fire services within this division is also contributing to organic growth.

We are very encouraged by the value proposition we offer our customers in our expanded lineup of first aid, safety, and fire protection services.

Our document management business continues to build nicely and has more than doubled over the past year.

Today our annual run rate is around $50 million in revenue.

This division is growing at a strong organic pace as well.

Our organic growth in document management services once again approached 40%.

Our focus continues to be on building a national platform in the shredding business, thereby utilizing our knowledge of route-based systems.

So in total, our revenues for the quarter of 823.5 million grew 10.4% with organic growth of 8.4% representing a 90-basis-point increase over that same in the fourth quarter which was 7.5%.

Now I will discuss our margins for the quarter.

Our rental margins were a strong 46% of revenue, this is a 60 basis point improvement over the prior year.

This improvement came from all areas of our rental operations, material costs, production expenses, and delivery costs.

Productivity improvements were driven by increased efficiencies in utilizing our rental inventory as well as efforts in research and development and Six Sigma which helped offset cost pressures in other areas.

Energy costs continue to be front page news for the entire nation in light of the cost escalations caused by hurricanes.

In the past few years our energy costs, which are natural gas, electricity, and gas for our truck fleet, hovered around 2.5% of sales.

Today they're closer to 3% of sales.

Specifically, in the first quarter, they represented 2.9% of revenue.

We have had many questions about how we manage these costs in our company.

We do not have a formal hedging program.

Our operations handle the purchases with local providers in each of their markets.

We've also been asked if we have flexibility to increase customer prices for this type of spike in energy costs.

In many cases we do, but we work closely with our customers to accomplish that.

So we do have the ability to offset some of this pressure but not 100%.

However, it is incumbent upon us to find other ways to offset these cost pressures, and that is why we continue to invest in research and development and Six Sigma initiatives, where we are constantly looking at ways to engineer out costs and enhance revenue producing opportunities.

In our other services revenue area, our gross margins in that area were a strong 34.2% of revenue.

We continue to see a favorable impact on our margins from the improved top-line growth in our national account sales division as well as the contribution from our first aid and safety division and our document management division.

Our selling and administrative expenses for the quarter were 27.1% of revenue or 40 basis points higher than last year's first quarter.

The vast majority of this increase can be explained by an increase in medical costs, professional fees associated with the outsourcing of certain human resource functions, and an increase in our bad debt expense.

The bad debt expense is based on our conservative accounting policy of reserving for outstanding accounts receivable balances until they are actually collected.

Our days sales outstanding, or DSOs increased by one day this quarter but we believe they should be back in line by the end of the second quarter.

At that time we should be able to recoup most of this increased expense.

Net interest costs were 7/10ths of 1% of revenue this quarter.

Our interest expense increased as variable interest rates continued to climb.

In addition, in connection with the stock repurchase program we decided against prematurely liquidating some of our investment portfolio but rather borrowed money throughout the quarter on our commercial paper program.

However, we are paying that back as quickly as possible.

At the end of the quarter we still had $46 million of commercial paper outstanding.

We would also mention that we terminated our interest rate swaps shortly after the quarter ended.

As a result, the interest on $225 million of debt reverted back to the fixed interest rate of 5 and 1/8th percent which we locked in, in May of 2002.

Our effective tax rate was 37.1% for the quarter which is up slightly compared to last year.

We anticipate this rate will increase another 10 to 20 basis points throughout the year as state and local taxes have increased.

However, we are working on some tax strategies to reduce the impact of these increases.

For the quarter, net income of 79.5 million increased 9.5%, and earnings per share increased 11.9% to $0.47 per diluted share.

Before we move off of the income statement we thought it would make sense to assess the impact that Katrina could have on our revenue and profits going forward.

As our news release said we have several operations in the Gulf Coast region which were impacted by Katrina.

At this point it doesn't appear that we incurred a lot of physical damage to property and buildings.

However, the business interruption is a different issue.

As of today, all our operations are open, including our operations in New Orleans and Gulfport.

However, many customers have been lost.

Many, we believe, are temporary, but some will be permanent.

This business interruption will be felt primarily in our rental operations but it will also have an impact on our national account sales division and our first aid and safety division which services hotels, casinos, and many other customers in that area.

Even with this reduction in revenue we kept our original revenue guidance intact for the year.

That guidance is for revenue to be in a range of 3.35 to $3.45 billion.

As for as the impact on earnings, this is even more difficult to predict because of the volatility in energy prices and the final insurance coverage for business interruption.

At this point, it is too early to quantify with any accuracy the bottom line impact of these issues.

As we noted in our press release, we believe we can achieve our original guidance of $1.95 to $2.05, but these events could move us to the low end of our range.

Now let me move on to the balance sheet which continues to be very strong The current ratio stands at a strong, 3.7 to 1, cash and marketable securities stood at approximately $258 million as of August 31.

As I mentioned, DSOs on accounts receivable were 38 days, a slight increase from last quarter due to higher sales growth primarily in the national account sales division.

Inventory levels increased 19% year-over-year.

In addition to serving a higher revenue base, certain events also contributed to this increase.

The national account sales division rolled out a new catalog in the middle of fiscal 2005.

In addition with the expansion of our first aid and safety division, into additional safety products, we have had some buildup in inventories to service that new platform as well.

We also rolled out some new uniform products in the rental division and many of those are being sourced outside of the United States, so our safety stock has had to increase on those products as well.

Accrued liabilities include an extra day of accrued compensation compared to August of last year and it's based on how our pay dates fell during the end of the quarter.

Our long-term debt stood at $511 million at the end of August, which is primarily made up of the $450 million of debt we incurred to purchase Omni in fiscal 2002 and the additional $46 million of commercial paper borrowed for the stock repurchases.

Total debt as a percentage of capitalization was 19.8%.

Now moving on to the cash flow statement, our operating cash flow for the quarter was $47 million compared to 53 million last year.

Capital expenditures were 36 million for the quarter and we expect capital expenditures to be approximately $150 million for the year.

During the first quarter we purchased $102 million of Cintas stock.

To date we have purchased 4.4 million shares at an average cost of approximately 39.50 per share.

These purchases represent approximately 35% of the total amount authorized by our Board of Directors in April.

We would now like to open the call to answer your questions.

Thank you.

[OPERATOR INSTRUCTIONS] We'll take our first question from Greg Cappelli with CS First Boston.

Mr. Cappelli, your line is open.

Yes, it's Eric filling in for Greg.

Sorry for the delay there.

Just a follow-up on the add/stops.

Can you give any more color as to what the most recent trend is, post the end of the quarter?

Eric, that didn't change much throughout the quarter.

It was pretty consistent.

And just again, reflects the seasonal nature of that service throughout the summer months.

Okay.

And a follow-up on the pricing.

We were a little surprised to see that stall out given increases you had seen over the last few quarters and given that that's a rolling 12 metric.

Is that any indication of where things should fall out over the next year?

Or do you anticipate that the tick-up based on the surcharges that you spoke of?

I would expect there to be an increase consistent with increases that we may see in some of our cost of operations, such as energy.

But it's really early to tell.

But I would think the speculation would be that it should increase going forward.

Thank you.

We'll move next to Greg Halter with Great Lakes Review.

Good morning.

Sorry, good afternoon.

Hi, Greg.

Hi.

Noticed the $21 million in acquisitions of businesses.

Just wondered if you could expand on that whether or not they're new acquisitions or any other earn-outs included in that number, and if there were acquisitions, what they were primarily.

There were several small acquisitions in those numbers, and they were -- they encompassed acquisitions in document management, first aid and safety, as well as uniforms, but they were all relatively small operations.

Okay.

And are you seeing any change in the landscape relative to pricing and so forth?

In acquisitions?

Right, and willingness of sellers to sell to you.

I think we've got a pipeline that is starting to fill up and I would tell you that I have not seen any changes necessarily in pricing, but I'm beginning to see more opportunities, perhaps, than what we saw 6 to 12 months ago.

Another subject.

On the increasing medical costs, I know historically you've done some sort of things there to help.

Did that occur this year, and what else can be done, and what kind of increases are you seeing on a year-over-year basis?

We could continue -- we have continued to see an increase in medical costs over the last several years, and our rate of increase has declined from what it was about two years ago but it's still in the high single-digit area right now.

What can we do about it?

Well, there's a couple of things that we are working on to do.

One is we are looking to make sure that our administrator is properly handling the activity from our employees so that they are obtaining the discounts that they're supposed to be obtaining, so there's auditing of that going on.

We are looking at the cost sharing with our employees, but we are very reluctant to pass on too much of a cost increase to our employees.

We feel that that's one of the benefits that Cintas provides to its employees, is great medical coverage.

And so we're making sure that we don't penalize our employees with regard to that.

We're also looking at education, as all companies are to make sure that our employees are using their medical benefits wisely.

And we've continued to offer inducements through preferred provider organizations, through mail order prescription drug services, et cetera, to help in that regard.

So I think that it's a combined effort of many different things but bottom line is that medical costs in this country continue to escalate at far greater rates than GDP, and we know that that is one of the attractive features that we have for our employees at Cintas.

So it's going to be a cost of doing business that we'll try to manage as well as we can.

Okay.

And one last one.

Karen, you mentioned about the swaps being terminated after the end of the quarter.

Is there any sort of either reduction of interest expense or increase of interest expense or gain/loss related to those that you'll be realizing going forward?

No, we pretty much terminated them when we were at a break even position, Greg, so with variable rates increasing as much as they did, with every fed increase that was impacting that variable rate we were paying, and when we were just about break even on those swaps, that's when we decided to terminate them.

Okay.

Great.

Thanks.

Thanks.

We'll take our next question from Bruce Simpson with William Blair.

Hi, good afternoon.

Hi, Bruce.

Can we talk a little bit about the rise year-over-year in SG&A as a percentage of sales?

I think you talked about three factors including the bad debt problem.

Can you quantify the approximate contribution of that 40 basis point year-over-year increase from the bad debt and from the other pieces?

Yes, it was pretty much even, and we think that as we commented we think we can recoup the bad debt portion and also as Bill was saying try to offset the other pressure from the other line items.

One of the areas that we'll come back, that we'll see improvement in, is we're going through a program right now of outsourcing many of our HR-type activities in the Company to a service provider, and so we're kind of incurring double costs right now as we pay down during the transition period, but longer term there will be cost savings.

So we will see improvement going forward on that.

So if you take out these things that sound as if they're sort of punitive on a nonrecurring basis what do you think is the normalized rate that we should be anticipating for SG&A as a percentage of revenue year-over-year?

Basically are we at the same level as the full fiscal '05, or has it deteriorated because of the cost of medical costs?

Bruce, I would tell that you barring anything unusual, I think that we should be able to achieve comparable rates to what we did in '05, despite higher medical costs.

Comparable rates to fiscal '05?

Yes.

Okay.

Then just one question with respect to energy.

I think you mentioned -- you used the language something like we think we can protect ourselves against part of the rise of energy costs.

Is there -- are you -- have you increased prices of the core business in response to higher energy prices within the last quarter and if not are you anticipating -- what are you anticipating in terms of either user surcharges or higher year-over-year increases to offset that?

The first thing I would remind everyone is that the energy costs really spiked right at the end of the quarter.

So we really didn't experience much of a significant increase in the cost during the quarter.

It was comparable, in fact, when Karen reported the 2.9% of sales, that was actually very comparable to what we saw in Q4 and Q3.

So there really wasn't any significant change.

The big increase in energy costs has occurred pretty much here in the first few weeks of the newest quarter.

So we're going to have to wait and see how that plays out.

While I think everybody recognizes gasoline costs have been declining in the last few weeks, in light of what's going on right now down in the Texas area with this latest hurricane, we really don't though what's going to happen going forward.

We can increase prices to our customers in a couple of different ways.

One is through -- on an annual contract renewal, which will occur throughout the year, but secondly, we do have some opportunities with certain customers, a vast majority of customers, to potentially increase service costs, but we're going to work -- we're going to be very careful on that because we want to be sure that we're working with our customers, and while we need to recoup some of our cost increases, as Karen said there's no way we're going to be able to recoup all of them.

I think what our operating guidance would tell you is that the increase in energy costs that is felt throughout the entire country has changed the mind-set of customers and they're more apt to accept a price increase than they were in the past 12 months.

So that allows us at these anniversary dates to go ahead and increase price with not much resistance as what we felt in the past.

So that's why we -- as Bill said, we think we're going to be able to recoup some of this going forward, just because of that changed mind set, and, in fact, we've got to pass some of this along to our people at the anniversary date of their contract.

The other thing we think we are going to have to do, and, in fact, we've just started a program to do that is we've got to look internally from a conservation standpoint and make sure we're efficiently using our vehicles, our utilities and the plants to make sure that we're minimizing the energy usage.

So I think there's going to be some opportunities we can have there also.

Okay.

Last thing is just Karen sequentially there's a 50 point deterioration in the add/stop metric.

You said you think a lot of that is seasonal.

Would you be willing to take a shot at quantifying that?

I would say all of it is seasonal?

We'll take our next question from Chris Gutek with Morgan Stanley.

Just a couple questions.

The garment amortization expense in the uniform rental business I'm curious how that's trending as a percent of revenue versus a year ago period.

Then specifically if there's still any lingering benefit from the new uniforms that were given to the former Omni customers that have become fully amortized but are still being used?

I don't have that breakdown in front of me but it continued to drop as we were talking about the rental margins.

There was a contribution from all three areas, the material cost reduction, the decrease in production expense, and the decrease in delivery costs.

And if I recall right, Chris, it was kind of evenly across those three.

It is no longer from the Omni acquisition though.

It's pretty much just the efficiency that we're seeing in our operations in utilizing the stockroom of inventory and doing some of the -- implementing some of the Six Sigma initiatives.

So Omni is out of the picture now as far as a reason for any reduction in material costs, and now it's efficiencies and other types of initiatives going on at the operating level.

Yes, let me give you some examples.

Karen alluded to the Six Sigma but some of the things that we're doing have resulted in lower material costs in some of these products through consolidation of SKUs through better negotiations and buying power with some of our vendors, and so some of that Six Sigma opportunity has come through through the lower garment costs.

And then switching gears, but staying focused on the overall company gross margin, I think the press release alluded to margin improvement trends within some of the newer lines of business.

I'm assuming that's referring to shredding and fire safety, could you guys quantify, or at least roughly quantify what those margins are for those new lines of business and what the impact is on the overall company's gross margin versus the year-ago period?

I don't know if I'm going to quantify them to your satisfaction but I in looking at those margins for the different product lines, they are as good on the first aid and safety side as the rental operations.

We have a little bit of room for improvement in the document management side because they continue to build that new platform of service.

And they improved to -- not to a great extent but to some extent on the national account sales division side.

So all three of those areas, national account sales division, the document management side, and the first aid and safety are contributing to that overall gross margin that is now roughly around 35% of revenue which, as you recall, Chris, it used to be the high end of our range.

Right.

And just for shredding specifically are those margins going up, and is that contributing to the overall company gross margin trend?

Yes.

Yes.

Finally, real quick, just on the share repurchases, it looked as if most of the shares were repurchased prior to the fiscal fourth quarter earnings release?

And if that's correct I'm curious is the intention going forward to be very selective with repurchases based on the stock price or conversely should we assume a relatively steady rate of repurchases in the short to medium term at a fairly agressive pace?

We will be aggressive to the extent that we have been given authorization by the Board based on their criteria.

Fair enough.

Thank you.

We'll move ton to Gary Bisbee with Lehman Brothers.

Hi, guys.

Several questions I guess.

First of all, it was a pretty surprising jump in your organic growth at the other services area and it sounded like it was all three of the main units there contributing.

In any sense as to how sustainable that is as we look out through the rest of '06?

Was there anything that was particularly, I guess, within the uniform sales, any big orders that you don't think are going to come through?

Are we likely to see somewhere in the upper single digits for the rest of the year?

I would say our expectations are, assuming a continuing, steady, economy improvement, that we should continue to see good organic growth in all those businesses.

And you singled out the -- like the -- I forget what you call them, the branded stuff, not just the uniform's, but shirts, and golf shirts, and hats, and all that type of stuff.

Did anything happen that spurred that on, or has that been fairly strong?

It's the first time I've heard you mention that in a while.

That's an interesting thing, that now once again, here's a new product and service that we rolled out maybe about 18 months, and really Gary what we had to do there was build our credibility with our customers.

There was one major customer who kind of pulled us into that business.

We built our platform around that particular customer but then we just continued to expand our systems, expand our product line, gain more knowledge in that, and it was something that I would say that just recently built up momentum as we've shown the credibility in that area.

But there's not any one particular customer that made that pop in the quarter.

Okay.

This is the first quarter in awhile that we've seen slightly down versus last quarter, sequential rental, organic growth rate.

Your investor day this past spring, I think there was a sense that you were talking about -- comfortable about double digit growth there within the next 12 to 18 months.

I wonder if that's still something you feel comfortable with, number one?

Number two, any willingness to quantify what the hurricane impact may be for the November quarter on that rental organic growth?

Well, let me take a stab at the first part of your question.

We are comfortable that we'll get to double-digit growth in our rental operations.

We think that this sequential decline of 3/10ths of 1% was more seasonal in nature and we are still bullish about getting that particular division up to double-digit growth.

We are so excited about the expanded product line in our facility services area, we've got a new comfort pant that we recently rolled out that's going to generate some nice growth in the uniform division.

And so that answers the first part of your question.

As far as predicting the impact of Katrina--?

I think that's going to be -- that's a very difficult thing for us to do at this time.

But here's what we're going to do for everyone is that we're going to be tracking that as well as we can, so that we can isolate any impact that the hurricane Katrina or the subsequent hurricane Rita might have on our operations, and we need to do that anyway because we need to do that for our business interruption claims, so I would tell you that you should be able to see -- or we should be able to report to you and you will be able to see what our organic growth is without the impact of those hurricanes at least as far as it impacts those areas.

Now, if these hurricanes have a more devastating impact on the economy in total, that obviously will be very difficult for us to quantify.

Okay.

I think you mentioned the bad debt expense you thought could be back on a more normalized trend in a quarter but is that taking into account any business you're going to have to write off from lost customers from Katrina?

Well, again, that should be covered by our insurance policy, so I don't think that should have an impact.

But is that the kind of thing where it could have an impact last quarter, then you get your claim in and you -- get six months from now you get paid?

Gary, it's -- that amount would be relatively insignificant to the Company.

One last question.

We've heard from G & K and also a couple just clothing manufacturers, some chatter around getting more aggressive in the national accounts sales business.

It sounds like yours is doing real well, but any change you've seen competitively in the last 6 to 12 months?

And how do you feel about that right now?

Well, we certainly see our competitors continue to improve their performance and we believe that our business is very healthy, very strong, we got good expectations for our national business, both rental and sales, we've got a great team out there that's bringing in a lot of new business so we'll just stay a step ahead of them.

I would add, too that we've got great sourcing strategy.

Those customers in that arena, they expect the best quality product for the lowest price they can get, and that means you have to have a very well oiled sourcing strategy, and we think we have it in place here.

Thanks a lot.

We'll take our next question from Brandt Sakakeeny from Deutsche Bank.

Thanks.

Hi, Karen and Bill.

Hi.

I'm sorry, I missed a response you gave.

I think there was an earlier question about fixing out some of the debt.

Did you respond to that?

Yes, well, we commented that we terminated an interest rate swap right after the end of the quarter.

That swap had been put in place, and had swapped fixed into floating.

Well, now we've terminated that so we're he back to the original fixed rate on that $225 million of debt and the coupon on that is 5 and 1/8%.

Great.

Sorry.

Missed that.

That's okay.

Second question, just wanted to go over CapEx again, you still want a range of sort of 1.40 to 1.50 in CapEx this year?.

Well, that's a great question.

We said earlier that we think it's around $150 million.

We have approximately six facilities in some phase of design and construction that's pretty comparable to fiscal '05, but we're still -- we're still predicting around $150 million for the year.

Okay.

And I guess a final question with respect to the add/stop ratio I heard you say that you thought that was seasonal.

You haven't seen any of your clients, be they in the transportation business, I guess, and the end markets, start to cut employees as a means of saving costs given the higher fuel environment that we are in right now?

Of course, no, we haven't yet, but the higher -- the higher fuel really just started at the beginning of this quarter.

So I think it would be too early for to us see that anyway.

Okay.

Great.

Thank you very much.

Thanks, Brandt.

Our next question comes from Pete Carillo with Citigroup.

Few questions for you.

On the lost business category in the rental side, just a quick question on that one is, were there certain services in there that helped account for some of that, or--?

Well, again, that was comparable to what we saw in the fourth quarter.

The 7.3% lost business rate.

What we have been saying in the last few quarters is that historically we were able to get lost business down to maybe a 5% level, maybe 6%, and we still think that we can make improvements on getting that 7.3% down into the 6% range but we would say that the expansion of our rental product line into facility services has shown some increased lost business because a lot -- many of those service are to companies like restaurants, and the mortality rate is higher in that segment of industry, and so it kind of reflects our product line expanding into a different type of industry group than where we had been in the past.

The next question was, in terms of -- what kind of traction are you guys seeing so far or expect to see down in the Louisiana-Mississippi area as the federal dollars start pouring in?

I guess whether it's either rebuilding cities or even in interim, some of these little temporary, I guess they're calling them tent cities, or whatever they are setting up, are you going to expect to see any kind of business down there?

I would think that there might be a need for sort of authorized type of people giving out different services or whatever.

We have had some inquiries so far from some big contractors and companies that would be providing some of the cleanup services down there but I can't tell you that at this time we've seen any increase in business.

Things are just starting to even get back to any semblance of business activity down there right now.

So it's too early to tell.

Okay.

Last question was really sort of surrounding the fledgling document management piece of the business, not the shredding part but the actual document and storage part of it.

We were at the pharma conference this week in Chicago and talked to a couple of people that were getting into this business as well, Shred-It was one of them and I guess they're just starting to start an operation up in Canada and getting ready to move down as well.

Are you guys -- are things going well still in that area of the business?

Are you planning on continuing to expand it, or how do you characterize that right now?

I take issue with your word fledgling.

Smaller but growing fast.

We're very pleased with what we're doing there.

Again, just to make sure everyone understands, there's two aspects to this business, there's the storage side and then there's the shredding side, and the shredding is primarily what Cintas has been focused in.

We are very bullish with regard to the shredding opportunities that exist.

We've made many acquisitions and we're growing organically as Karen pointed out very well, and it is a -- just a very exciting business.

We think that it has great, great potential for Cintas.

The storage side is a very interesting business.

We bought two storage companies relatively small.

We have not purchased any other storage companies at this point in time.

We bought the storage companies primarily because they were a great opportunity for us and we're very pleased with what we got but we bought them also to look at the synergies that really exist between shredding and storage and to determine does the business model of storage make sense for Cintas, and do we have the growth potential there that we do in the shredding side and in some of our other businesses.

So the jury is still out as far as Cintas is concerned with regard to how active we want to be in enhancing our storage capabilities, but we are very, very excited and are continuing to aggressively pursue a lot of shredding opportunities.

Great.

Thanks.

Next we have Michel Morin with Merrill Lynch.

Good afternoon.

Couple of questions.

First, on the add/stop you mentioned seasonality.

Perhaps I'm missing something here but if this is calculated on a 12-month basis I was wondering how or why seasonality would be a factor.

Perhaps I'm probably missing something here.

Well, again, it's looking at the last 12 months, and the last 12 months has improved.

But the most recent quarter does show that most of the weeks during the quarter -- in fact, let me see, Michel, it was approximately 8 out of the 13 weeks were negative, and so that had a detrimental impact to that add/stop ratio.

So basically the seasonal effects that you usually see were even worse this year, essentially?

Yes, compared to last year, they look pretty comparable to a couple of years ago, but compared to last year it was a little bit more negative than what we've seen in the past.

Okay.

Then you talked about outsourcing of some services.

I was wondering if you can give us a bit more color as to what you're doing there.

I can only tell you that we are outsourcing some of the activities associated with our benefits, human resource and payroll type activities to a third-party provider.

Okay.

So that presumably is really all in the SG&A line and there would be no real impact at the cost of sales side?

Right, yes.

It's basically, despite -- will ultimately be displacing internal SG&A costs for lower professional services fees but they all appear on the SG&A line.

Then finally on the rental gross margins, the 46% number is the highest I have on record going back, I think to 1990 or something like that.

And in particular it's just past the peak that you had reached prior to the Omni.

I was wondering if you could comment a bit about -- a bit on the outlook there, obviously fuel costs and energy costs are an aside perhaps -- what's changed if you look at where the Company was perhaps prior to Omni?

Should we be looking that it number reaching new highs going forward, I guess is where I'm going with this?

Well, really depends on future acquisitions.

Because you're looking at some history that has a lot of acquisition activity -- we've gone, you go back to 1988, we've made some huge acquisitions in the last seven years, and so that kind of -- makes you take a couple of steps back and integrate those companies and it has an impact on margins.

So now we are three years beyond the most recent acquisition or sizable acquisition of Omni, so you're starting to see some nice improvements.

The other thing that I would say is that we've got this Six Sigma initiative that just was instituted in the rental operations last fiscal year, and we're just in the infancy of seeing the impact that that's going to have on those operations.

But I guess that's not really answering your question, Michel, but it really -- it depends on the number of acquisitions going forward, will impact that line item, and the pace at which Six Sigma has -- the initiatives have on those rental operations.

Great.

Perfect.

Thanks very much.

We'll take our next question from Michael Schneider with Robert Baird.

Good afternoon, Karen and Bill.

Hi, Michael.

Just a couple of finer points on what's been asked already.

I guess, first, the SG&A line.

You guided that you expect it to be flat in percentage terms year-over-year.

I guess I'm a little perplexed by that because if you look at last year you had a huge ramp in the sales force, you had healthcare that was up double digits also last year, you had the Six Sigma launch which I know from other companies has a huge up-front expense so why is it that SG&A would only be flat this year in percentage terms?

Well, I would tell you that was probably an accountant's conservative estimate but, Michael, we certainly are striving to improve costs, but I do see continuing pressure from medical costs.

I continue to see legal expenses at rates comparable to what we've seen in the last several quarters.

And it's just -- sales expense will continue to hopefully be managed at the levels that we're at today but we're also going to make sure we take on any opportunities that we see are out there.

One of the things we've always said is that our stated goal is for after tax margins of between 10 and 11% and while we are not there in this quarter we certainly are hopeful to be there this year, and as those margins continue and improve through improved rental gross margins and other gross margins, we may invest a little bit more in the SG&A line to -- especially the S side of the SG&A line to improve for future growth so that's why I gave you the comments that I did.

Okay.

Fair enough.

Then on the add/stop rate, to Michel's point that this is calculated on a trailing basis and given, while 50 points doesn't sound like much it appears to me for it to move that much in one quarter the uniform business itself must have been the culprit, the core uniform business.

No, that's not what we're seeing.

It's really in the facility services area, because I looked at the add/stops for a number of people in uniform and that really just as I've said before is kind of just sluggish.

It was negative but it wasn't negative in a large way, and much improved versus the first quarter, first three-quarters of last year as a matter of fact.

It turned positive slightly.

If you remember this, it turned -- the number of people in uniform within existing accounts turned positive in the months of October and November, and then again in May.

So this negative trend that we saw in the number of people in uniform was not significant.

That tells me that it's in the facility services area and we know that there is a lot of seasonality.

Now, Eric asked me earlier if there was a change in trends at the end of the quarter and I said it was pretty much , the same pace all quarter, but I don't know if you guys hang on it week by week but the last two weeks did turn positive.

So again, we don't like to hang on one particular week to predict a trend, but it did turn positive in the last two weeks.

Okay.

Then as you know, we survey a lot of the private companies in the industry and it's our sense that the core uniform business, the uniform rental business is growing somewhere, call it 3 to 4% this year.

Is -- I know you don't like to delve into the specifics of the rental business but can you at least give us some sense as to whether your, again, core rental business is growing as fast or faster than that range?

We're in that range and we're in the high end of that range.

Fair enough.

Then just the revenue guidance for the year.

If we look now, organic growth did decelerate a hair.

You've got Katrina that's going to hit you in the coming quarters, in a much bigger way.

I'm still surprised that the revenue guidance is unchanged.

Is it that you just haven't adjusted it or what is actually better than you expect to actually hold that range where you had it?

Well, I think you're overplaying the Katrina impact, I think, Michael.

I don't think it's going to be that significant in the total scheme of things as far as our revenue.

For example, I spoke to one of our corporate people which was actually in our New Orleans operations today, and that operation has been running this week and they're serving customers, they're telling me their businesses are open around there.

Fortunately our operation is in the western side of the city, which wasn't flooded.

And so I think that there's going to be activity there that we feel very comfortable that while we're not going to recoup all of it there's going to be a good piece of it.

All of our other operations are up and running that were -- even though they were shut down for a week or so Jackson, Mississippi, Tipito, Louisiana, Baton Rouge, Mobile, Alabama, Gulfport, Mississippi, they all are running.

Now there will be some lost customers but it's coming back.

So it's just not as significant.

We were talking a $100 million spread here between the low end of our range and our high end of our range in revenue and Katrina itself is not going to have that great an impact on that total revenue line.

Look at our revenue for the quarter.

We grew 10.4% this quarter and we had a very strong result in our other services, and while the rental division, or the rental segment was not -- did not show as much of an increase as we would have liked to have seen it still was 8%.

So we feel comfortable that that range of revenue that guidance we gave is very achievable.

In fact, on that tone, in the rental group, the acceleration that continues in the new business written, can you give us some sense of what products are actually succeeding most on the new business written?

Is it still the mats or is it the hygiene activity?

Michael, I really am reluctant to tell you because I know my competitors are listening very closely to this call.

As a result I'm not going to get into the details of that, we are comfortable though that we are increasing at rates in all our product lines consistent with what our plans are.

That's all.

Congratulations on the gross margins.

Very impressive.

We'll move to Gary Bisbee with Lehman Brothers.

Just two quick follow-ups.

You referenced the -- just under 3%, the energy costs.

Are you willing to give us a sense as to how that splits out amongst the three areas?

Is it fairly even?

Yes, I am.

I am willing to tell people this, because I know all of you are going to have to do your own modeling as to what you expect costs to be but of the approximate 2.9% that we had this latest quarter, about 9/10ths of a percent of that is related to natural gas.

Then about 0.75% or so, 0.75 to 0.8% is related to electricity, the remainder is related to diesel and gasoline to handle our fleet.

Thanks, that's helpful.

The second question is just, can you give us any color on geographically across the U.S. where you're seeing the most strength and/or any weakness?

Are some areas growing a lot faster than others or it has been a pretty even acceleration of your growth over the last 12 months? .

I'd say it's been relatively even over the last 12 months.

I don't think I've -- I sense any one region outpacing another by that significant amount.

Great.

That's it.

Thanks.

Next we have Greg Halter with Great Lakes Review.

Hello again.

Thanks for taking the additional questions.

Karen, you mentioned about the taxes going up, I think 10 basis points with a further increase expected on the -- primarily I think on the state tax side.

I know we've had a reduction here in Ohio, but do you have any comment on other states and what you're seeing there as well as what potentially you can do to lower that?

Well, we -- the state of Ohio we have seen a reduction.

In fact, that's why our rate this quarter was 37.1 as opposed to about the 37.2 to 37.3 which Karen indicated will be going forward, because the way the law changed here in Ohio gave us a slight benefit for this quarter but will be going forward.

The problem, Greg, is in many of the other states, is that they are eliminating a structure that we had in place that allowed us to take deductions for certain business activity, and as a result of that, the state tax rates effectively are going up for Cintas.

There are things that we can do with regard to our legal entity organization, and how we are structured to do business, and that's what we're working on.

However, those opportunities are probably more to just keep us in the 37.3 to 37.4 range going forward for the future, and that's what I effectively am telling people to model going forward because I think the old rate that we had of 37 even is probably by the wayside.

That's helpful.

And is it possible for your rental gross margins to get up to 50% at some point over the longer term, and if so how could you get there?

We say nothing's impossible, but obviously that would take some significant improvement in either material costs, labor rates, or plant utilization, I mean those are the big costs, and I don't think you're going to see that significant an improvement in the labor rates.

Material costs we're doing a lot of great things through sourcing in other countries and utilizing both tariffs and all sorts of activities to do that.

Plant utilization only can go up so far so I don't think you're going to -- I think to get to 50% would be pretty far reaching.

Okay.

That's helpful.

And I haven't heard you discuss the sales force productivity, and I know a couple quarters ago it was a big issue, but can you bring us up to speed on that?

Not a big issue, but an important issue, I guess.

We did briefly comment that sales productivity did improve again this quarter.

We think that we still have some room for further productivity improvements, but we did get back to a level that we've seen in the past and that we were trying to -- we were striving to get back to.

So -- but does that mean we can't go any further?

No.

We are always expecting higher productivity from our sales force as we introduce new products to them and help them get new business.

Okay.

One last one is, do you have the dollar figure for the allowance for bad debts at the end of the quarter?

On the reserve?

Yes.

At the end of the quarter, the accounts receivable bad debt reserve was 20 -- I'm sorry, 12.8 million. 12.8 million.

Up from I think 9 at the end of the year? 9.9?

9.9.

Good memory, Greg.

Thanks.

We'll take Pete Carrillo with Citigroup.

Just one quick one.

Do you have an operating income break out for us?

I do.

The operating margin on the rental business was 18.5%, and on other services revenue 8.2.

Thanks a lot.

You're welcome.

And our final question comes from Thatcher Thompson with CIBC.

Hi, Karen and Bill.

Hi, Thatcher.

With regard to share repurchases, what are the blackout periods when you can no longer be in the market buying?

Barring a -- let's say an unusual event, like a big acquisition that's pending or we're in negotiations on or something along those lines, Thatcher, generally we follow the period -- the blackout period being from the middle of the last month of the quarter through the date of earnings release.

All right.

So you've effectively been out of the market for over a month now?.

Well, no, not necessarily.

We will enter into a 10b5 filing that would provide our selected broker to do certain purchases if certain criteria would happen to occur and we did, in fact, execute some buys during this quarter.

Under that 10b5.

Okay.

But the traditional blackout period is from the midpoint of the last month of the quarter through the, say, the earnings release?

Correct.

Okay.

And just so I understand this completely, with regard to price increases and possible surcharges for fuel costs.

A surcharge you can implement at any time to all clients at your--?

No, we can't.

We have contracts with our customers.

So it would only happen on the anniversary date?

Well, you said a surcharge.

I don't want to lead the impression that we have the ability to just add a surcharge.

We've got to follow our contractual agreements that we have with our customers, and they provide for the annual price increases, and in certain -- in many cases, our service charge will allow us to be -- we will be allowed to increase the service charge as a result of things like increased fuel costs.

But that service charge is something you can only do once a year on the anniversary date?

No, no.

The contract in many cases allows us to do that when costs have increased to a level that we need to increase it.

Okay.

I guess the question is is right now, given fuel costs have been up for almost a month now dramatically is your inclination to increase price of contracts when they hit the anniversary date or increase that surcharge or service charge?

Well, they haven't been up for month yet.

They've been up for about three weeks, and they actually were starting to come back down last week, and what we have done is we've been continuing to evaluate it throughout our company on a customer by customer and business by business basis.

So we have not dictated anything from a corporate perspective of what they should do.

We allow a lot of that discretion within our operating units to decide what they are allowed to do under the terms of our contracts, what they should do for our customers, and what they feel is the right thing to do.

Any trend in what they're tending to do in the last three weeks?

Well, the tendency is that we need to do something to recoup some of these additional costs.

Have they done that in the last couple weeks?

I don't think there's been a massive increase in service charges to do that, though.

Thatcher, if I could add to that I know that they -- as Bill said they sit down with their customer list, they look at their prices, they look at the margin analysis for the account and they look at when the last price increase went into effect and they look at is the contract coming up for renewal shortly, so as Bill said there's so many factors that go into this it's not just a universal mandate that they can go across the board and increase price.

But they do use their discretion to go in selectively and increase it and just -- but stay in accordance with the contract.

Our gasoline prices here in the Midwest had dropped almost $0.50 a gallon here in the last week and a half, so it looked like they were coming back down.

Now, I'm sure they're going to go right back up here especially in light of what's going on down in the Gulf today.

Okay.

All right.

Thank you.

Thanks, Thatcher.

There are no further questions in our queue.

I'll turn it back over to you Mr. Gale for any final or closing remarks.

Well, thank you all very much for joining us this evening and hopefully we were able to answer your questions.

There is a little bit of uncertainty out there right now but as I said we feel very comfortable at this point in time with the guidance that we did reiterate.

We expect to release our second quarter earnings during the week of December 19.

We'll look forward to speaking with you at that time.

That does conclude our conference call.

We do thank you for your participation.