信達思 (CTAS) 2006 Q2 法說會逐字稿

Good day, everyone and welcome to the Cintas second 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.

Good morning.

Thank you for joining us today.

We are pleased to announce increased sales and profits for the quarter ending November 30, 2005.

Our rental business grew at a rate in excess of 8% and other service revenue grew at a rate of 18% resulting in a combined revenue increase of 10.4%.

This came despite the impact the hurricanes had on our revenues.

We estimate that the three recent hurricanes reduced our revenues by over $6 million.

Fortunately, all of our impacted facilities are operating, although business at our directly impacted operations has not yet returned to levels prior to the storm.

Net income increased to $78 million, while diluted earnings per share increased by 7% to $0.46 versus $0.43 last year.

This increase in net income comes despite an increase in our energy costs of over 60 basis points from the first quarter of this year, and over 80 basis points from what energy costs were as a percent of sales in the second quarter of fiscal 2005.

Additionally, we estimate that the hurricanes impacted our pretax profits by approximately $4 million.

We are continuing to work on our business interruption claim with our insurance company, but at this time, no proceeds have been received or any receivable recorded as a final agreement has not been reached.

Had it not been for the impact the hurricanes have had on our operations and the resulting spike in energy costs, we estimate that our results would have been approximately $0.03 higher than what has been reported.

Our current guidance of revenues for the fiscal year ended May 31, 2006, remains unchanged.

That guidance called for total revenues of 3.35 billion to $3.45 billion.

However, we are narrowing our EPS guidance due to the impact of the hurricanes and higher energy costs to an estimated diluted earnings per share of $1.93 to $2.

We would also caution you to factor in, into any estimates you make, that our third quarter will have 64 workdays, while the fourth quarter historically, our highest quarter, has 66 workdays.

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

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

Good morning, everyone.

Let me go through the income statement first with a little more detail.

As Bill mentioned, total revenues were 835.8 million for the quarter, a 10.4% increase over that reported in the prior year.

In this quarter we had 65 workdays, the same number of workdays as the second quarter of fiscal 2005, but one less workday on a sequential basis from the first quarter of this fiscal year.

As Bill mentioned, our third quarter is a short quarter, from a workday perspective, with only 64 workdays, while the fourth quarter has 66 workdays.

These workday breakdowns are exactly the same as the number of workdays in fiscal 2005.

Rental revenues were 632 million compared to 584 million last year.

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

Acquisition volume accounted for roughly $3 million of contributed sales in this second quarter from acquisitions that had been made over the past 12 months.

During the quarter, hurricanes Katrina, Rita, and Wilma caused us to lose roughly $4 million of revenue in the rental operations.

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

Organic growth, excluding acquisitions, was approximately 7.7%.

However, excluding the impact of the hurricanes, our rental organic growth rate was approximately 8.4%.

This represents a 240 basis point improvement over the second quarter last fiscal year, and a 70-basis-point improvement from the first quarter.

Let me go through some additional metrics behind this organic growth rate figure.

Our new business, which has been booked over the past four quarters, contributed 14.4% 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 140 basis points of improvement over last year's second quarter, and it's 40 basis points higher than the first quarter's new business growth.

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 sales people in our rental operations.

Price increases to our existing customers contributed 2.1% in growth during the quarter, which is a 110 basis point improvement over the first quarter of last fiscal year, and it's 50 basis points higher than the first quarter of this fiscal year.

Last quarter we commented about our ability to get price increases in an environment where fuel costs have increased dramatically.

During this quarter we were able to pass on some of those increases to our customers.

Lost business and add/stops, and let me remind you add/stops is the measure of business within existing accounts, are the other two metrics that determine organic growth.

These two metrics were negatively impacted due to the disruption from the hurricanes.

Our Gulf Coast operations were closed temporarily, and to this day, many of our customers have yet to reopen.

Many companies are partially staffed as they get back on their feet and rebuild their businesses.

So in some cases we have truly lost customer accounts because those businesses are gone.

In many other case we have seen shrinkage within our accounts because the business are up and running but have not fully recovered.

With that said, our lost business for the quarter was approximately 7.8%, and our add/stops were a negative 1%.

We know that the hurricanes reduced our rental revenue by roughly $4 million, and subtracted 0.07% from our growth rate, so when adding this back to the metrics just mentioned our organic growth was 8.4% versus the 7.7% we reported last quarter.

The only other comment we would add about the impact of the hurricanes is that by the end of November, we had recovered about one-half of the business we lost due to the hurricanes.

Now let me move on to other service revenue of $204 million which increased 18% from last year.

On an organic same workday basis this segment of our business grew 9% without the benefit of acquisitions.

Other services revenues comprised our national account sales division, our first aid and safety division, our fire protection services, and our document management division.

These divisions were also impacted by the hurricanes during the second quarter.

According to our estimates, we lost approximately $2 million in revenue due to the impact of the hurricanes on our cruise line and hotel business in the Gulf Coast region as well as our document management and fire services locations in Florida.

Excluding these events, our organic growth rate would have been closer to 10.5% versus the 9% we recognized for the quarter.

We anticipate being able to recover about one-half or $1 million of this lost revenue in the third or fourth quarter of this fiscal year.

To give you some further detail on the performance of our business divisions that are included in other service revenue, the national account sales division and catalog sales to our rental customers together had an organic sales growth of 6.3%.

However, when excluding the impact of the hurricanes, these sales increased 8%.

The first aid and safety and fire services business grew 30% during the quarter and 12% on an organic basis.

This compares very favorably to the 10% growth in the first quarter.

Annual revenue from this division is approaching $300 million.

Our document management business is growing at a strong organic pace as well.

Our organic growth in this business division was approximately 43% during the quarter.

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 revenue for the quarter of $835.8 million grew 10.4% with organic growth of 8% and approximately 8.5% without the impact of the hurricanes on our business.

In summary, the hurricanes had a negative impact of close to $6 million on our revenue, 4 million in the rental business and 2 million in other services revenue.

As I mentioned before, the lost business in the rental operations, which were impacted by the hurricanes, has been reduced by approximately 50%.

And we anticipate recovering about $1 million in the lost revenue in the national account sales division prior to the end of our fiscal year.

Now let me discuss our margins for the quarter.

Our rental margins were 44.6% of revenue, which is comparable to the second quarter of last year.

Please recall that our rental margins improved in the first quarter by approximately 60 basis points over the prior year.

We would have shown that same improvement in the second quarter had it not been for the spike in energy prices in our company.

During the quarter energy costs were 3.5% of revenue, an 80 basis point increase from last year's second quarter, and a 60 basis point increase from first quarter.

As I mentioned earlier, we were able to recoup some of this increase in the form of price increases but the spike definitely hurt our margins in the short term.

The higher energy prices cost us approximately $0.02 per share during the quarter.

As we all know, some of the pressure from higher energy prices has recently abated.

In addition, we continue to evaluate our pricing to our customers and making adjustments where possible.

We also are confident we can offset some of this margin decline with Six Sigma initiatives and other cost savings programs in the rental operations.

Additionally, rental margins were impacted by the hurricanes in a couple of ways.

First, we lost the revenue, but the vast majority of the cost of running those operations is still in our numbers.

We continued to pay our people while we were shut down.

In addition, we continued to amortize our rental inventory, the uniforms, mats, and all other rental items, and we had the fixed cost of the operation which included building depreciation.

The Company also dedicated resources and monetary assistance to our impacted employees.

Now let me move on to other services revenue margins.

The gross margin in our other services revenues segment was 33.6% of revenue, a 160-basis-point improvement from the second quarter of last year.

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.

Similar to the rental margins, we had the impact of lost revenue in our national account sales division and these other business services, but incurred the fixed cost of those operations, although not to the same extent as the rental operations, which have material cost to amortization.

Now let me move on to talk about selling and administrative expenses.

Our selling and administrative expense were 26.3% of revenue, or 60 basis points higher than last year's second quarter.

Approximately 25 basis points are attributable to the hurricane impact and the lost revenue of $6 million.

In addition, we wrote off a $700,000 receivable from Delta Air Lines due to the bankruptcy filing.

The remainder of the increase was due to such items as medical costs, Workers' Compensation, and professional fees which were associated with the outsourcing of certain human resource functions.

We also have a joint venture with a mat manufacturing enterprise that incurred higher raw material costs during the quarter and thus reduced our earnings from that venture.

Going on to our net interest costs, which were 0.07% of revenue this quarter was comparable to last quarter.

During the quarter we paid off all of our commercial paper outstanding which we had borrowed on a short-term basis in order to fund some of our stock purchases.

Our effective tax rate for the quarter was 37.3%, which is up slightly compared to last quarter, but in line with our expectations for the remainder of the year.

For the quarter, net income of $78 million increased 6% and earnings per share increased 7% to $0.46 per diluted share.

As I briefly mentioned earlier, the spike in energy costs cost us approximately $0.02 per share.

In addition, the net impact of the hurricanes cost about $0.01 per share.

Had it not been for those two issues, our EPS would have been around $0.49 per share, or an increase of 14% over last year's second quarter.

Now moving briefly on to the balance sheet, the balance sheet continues to be very strong.

Cash and marketable securities stood at approximately $256 million at the end of November.

DSOs on accounts receivable were 39 days, an increase of 1 additional day from last quarter.

This increase was partially due to the impact of collections in the hurricane areas and the delay in payments by customers due to their own cost pressures.

Our receivables balances are not where we want them to be.

But we are confident that we should get those receivables back in line with historical levels by the end of the fiscal year.

Inventory levels fell from the prior quarter by approximately $9 million, or 4%.

And our long-term debt stood at $462 million at the end of November, which is predominantly made up of the $450 million of debt that we incurred to purchase Omni in fiscal '02.

Total debt as a percentage of capitalization was 17.7% at the end of the quarter.

Now addressing the cash flow statement, operating cash flow of 159 million in the quarter compared to 144 million last year was a 10% increase.

Capital expenditures were 34 million for the quarter, and we expect CapEx to approximate $150 million for the year.

During the second quarter, we purchased close to 300,000 shares of our stock.

To date we have purchased approximately 4.4 million shares at an average cost of $39.53 per share.

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

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

Thank you. [OPERATOR INSTRUCTIONS] Once again, please press star 1 if you have a question.

First we'll go to Greg Capelli with Credit Suisse First Boston.

Good morning, everyone.

Good morning, Greg.

I wondered if you could just comment on -- I know you don't give out monthly add/stops but if we think about how the quarter progressed was it relatively even throughout the quarter in terms of your same-store?

Actually, Greg, I looked at that briefly, and it strengthened in the last month, and especially the last couple of weeks, and that's not unusual.

We're going into the winter months when our entrance mat business picks up.

We also saw that our number of people in uniform actually turned positive from a net add/stop basis in that month of November, which is also comparable to the same trend we saw last fiscal year.

So on the rental side it actually turned positive?

Yes.

On the net add/stops, which you were asking about.

Okay.

Great.

Then you guys talked about the sales -- the productivity of the sales force.

Can you just talk about what you expect in terms of headcount growth throughout this year in the sales force?

Has anything changed there?

Greg, we're pretty much -- we want to stay away from giving specific increases or changes in the sales force, for competitive reasons.

But we're growing the sales force in line with the top-line growth expectations that we're giving the Street, and so we manage that according to our goals for top-line growth.

Okay.

So from a retention perspective, are you satisfied where things are at this point?

Well, we always think we can get better at retention but we are very satisfied with the improvement that we've made recently in the retention of the sales force.

Great.

Just two more quick ones.

On the pricing front, I think this is the highest level I can remember in some time that you have gotten.

Do you expect to remain above 2% for the rest of the year, the fiscal year?

Well, I think, Greg, that's difficult to predict, but given the fact that we have the ability within our contracts to raise prices reflecting cost increases, and given the higher energy costs, it would be logical to assume that we could continue to pass through price increases to our customers in accordance with our contract provisions.

Okay, Bill.

So the jump to above 2% was largely driven by what you've seen on the energy price front?

Well, certainly that had a big impact on it.

Remember, that's a 12-month figure.

So the fact that it's been going up indicates that we've been able to pass on price increases more recently, and obviously that's due, in our minds, to the energy costs, because it's truly attributable to that.

Okay.

Last one, just on the guidance.

What are you assuming for energy costs, just directionally?

Are you assuming flat from current levels?

Right now I'm assuming a slight reduction in the gasoline cost to do our -- to run our fleet.

However, it's offset to a certain extent by the natural gas costs, which, again, we use primarily in our processing plants for boilers and heating the plant, et cetera.

So all in all, I think it will be slightly less than what it was in the second quarter, and that's what we factored into our guidance, but we still have that $0.07 range, and that will hopefully account -- accommodate any behavior that those energy costs might have barring a significant runup like we saw from the first quarter to the second quarter.

That's very helpful.

Thanks so much.

Moving on, we'll go to Michael Fox with JP Morgan.

Hi, good morning.

Hi, Michael.

Do you guys still expect organic growth to return to the low to mid teens?

Then I have a follow-up on that one.

Yes, we're still comfortable that we can achieve that in a normalized economy.

Okay.

So what type of economic environment would you need for that to happen?

Because it seems like the economy is pretty strong.

Is it just that people's perceptions have changed so quickly over the past few months, as far as kind of the stutter step economy that we've been going on to?

Well, Mike, remember, what we're -- we're always measuring over the last 12 months, and certainly our trend has been improving every quarter, so we are moving in that direction.

Okay.

And then what are you guys assuming for an impact on hurricanes for the rest of the fiscal year?

Well, the only -- that's difficult for to us say, you know.

As Karen pointed out, about 50% of the business in the rental operation at our directly impacted operations has returned.

We continue to see a modest improvement in those impacted regions almost every week.

Some of our national account direct sale business will return.

We're hoping in the third and fourth quarter as the Gulf Coast hotels and casinos and cruise lines continue to reestablish their operations.

So I'm not sure if everything will ever come back in New Orleans.

But by and large, the majority of it we would expect to be back in line by the end of the fiscal year.

Okay.

Thanks a lot.

Next we'll go to Gary Bisbee with Lehman Brothers.

Hi, good morning.

Hi, Gary.

couple of questions.

I guess just a real big picture macro one first.

There's been an awful lot of press written about the challenges at Delphi, Ford, and GM.

Can you give us any update as to what your exposure is if you've calculated it, to some of the plant closures that those three companies are talking about over the next couple of years?

We have business with some of those -- I think with all three the companies, but it's nothing significant.

We have not really factored it into our numbers.

But I would not expect it to have a major impact on us at all.

Okay, thanks.

The SG&A, I guess the hurricane impact and the write-off for Delta explained a lot of the higher spend than we were looking for, but it still seems like you're not quite getting the leverage on that line item from the improvements in sales force productivity.

And is there anything else going on there?

Any other sort of one-time costs or costs that weren't in last year's numbers?

And I guess the second part of the question, would it be reasonable to assume that as we move forward over the next couple of quarters we'd return to year-over-year leverage coming from that line item?

Well, we -- if you take out the two items you mentioned, then basically what you're left with are some of the same cost pressures that many companies are facing in medical benefits and Workmen's Compensation costs, et cetera.

We also obviously have continued to have higher costs associated with corporate governance requirements caused by Sarbanes-Oxley, by the ongoing campaign against Cintas, the corporate campaign that the unions have, which has increased some of our legal costs and professional services fees.

Karen mentioned the Hewitt, the outsourcing of HR processing to the Hewitt Company.

We're incurring costs now for savings into the future, that will certainly go away.

It is our intention to lower our SG&A costs.

It is our goal to do that.

But there are certain cost factors that will continue as long as we're in the strict regulatory environment that we continue to be in.

I'm hoping that we're seeing a moderation of medical costs.

We have begun to see that.

The increases are not nearly what they were before, so we think that those programs are starting to have some impact and the inflation there is starting to dissipate somewhat.

So I'm confident that as we look into the future, barring any unforeseen events our SG&A will show some leveraging and show some improvement.

Okay.

Given the success of the first aid and safety and document management business, at some point -- is it today reasonable to start thinking about ratcheting up a bit the 30 to 35% gross margin expectation you've put out for other services, or is that something that would make sense in the future, or is there still a real possibility in your mind that we can end up in the lower half of that range at some point?

Well, our goal is definitely to get to that to a 35% level but as we're building these new business services there are some extra costs of building that national platform, especially in the document management group.

So, Gary, from a modeling perspective, we just continue to want to make progress toward that goal.

We are confident that we can get there.

These businesses are showing nice profit margins.

They are definitely adding to the profitability of the Company, but as we said, in these initial phases of building those new service platforms, it's a little costly right now.

Okay.

Great.

Thanks a lot.

Next from Morgan Stanley we'll hear from Chris Gutek.

Thanks, good morning, Bill and Karen.

Good morning.

Just to dig maybe a little bit more into the cost structure, you said that energy in total was 3.5 percentage points of revenue.

What was the breakdown between gasoline, natural gas, and electricity?

Just a second.

I think I have that somewhere here.

Chris, it was -- natural gas was about 1.15, and electricity was approximately, oh, 75 basis points, then the rest would be diesel and gasoline.

Okay.

And then the garment amortization cost, is that still contributing to gross margin expansion, or how is that comparing year-over-year?

Year-over-year that did improve.

And there's still some opportunity there, you think?

Yes, that's again, a function of top-line growth, and it's a very dynamic thing.

The operations do their best in pulling used stock from the stockroom, which gives us some benefit from a margin standpoint.

There's also -- they feel, if you talk to any of our operations people, they feel that they always can make more improvement in that area, and that's what we're seeing contribute to the margin expansion.

So to answer your question, yes, there's always improvement to be had, but you have to factor in any time there's a -- we've got top-line growth with new business coming on as strong as it is today, it impacts material costs, because every time we write new business, we install brand-new garments.

So we have to factor that in.

But the long and the short of it is we're still making improvement in the material cost expense in the Company.

And as a percent of revenue what is the increase year-over-year in your total labor cost, including healthcare, Workers' Comp, unemployment insurance, and other kind of benefit costs?

We don't have that available to disclose publicly, Chris.

And then finally the -- what is the exact status of the insurance claims regarding the hurricanes?

Do you have -- have you quantified that internally in submitted claims, or is that still yet to happen?

Is this a fiscal '06 event or maybe a fiscal '07 where you might receive some recovery proceeds?

Well, the claim that -- we have submitted a claim, but the claim is based on not only what has happened to date but also what we expect to happen into the future.

For the period of time.

I -- and I'm not going to be able to disclose that amount of that at this time.

My hope is that we will reach agreement with the insurance company this fiscal year but I can't guarantee it.

And we're working very hard with them to get this resolved, but they are taking a very diligent view of the numbers as they are with all their customers, and I just don't have any control over when that will happen.

Can you disclose that claim size?

No, I'm not going to disclose that.

Great.

Thanks.

Next we'll go to Michel Morin with Merrill Lynch.

Yes, good morning.

A couple of questions.

First, it looks like the amount spent on acquisitions ticked up, it seems like it's the highest number you've had in a long time so just want to get some color on what you're seeing in the market there, and presumably it's mostly document management related?

It's, majority of it is document management related.

There were a minor amount of uniform rental acquisitions and first aid acquisitions in those numbers, too.

Okay.

And are you seeing just more opportunity?

Is this kind of a new level that we should be looking at going forward?

Or how should we look at this number relative to what you've been doing?

Michel, I never predict acquisitions.

What I will tell you that the pipeline is fuller than it has been for awhile.

We are being more aggressive in terms of our willingness to acquire companies in the document management business throughout the country, primarily, of course, in shredding.

We have now a structure that will enable us to manage those in any part of the country.

We're continuing to make progress in the first aid and safety area, primarily in the fire services business.

That has ticked up.

And I'm seeing more opportunities potentially happening in the uniform rental side.

So I'm pretty optimistic going forward, but I'll never tell people -- I can never give you a number to bake into your numbers because they can be so volatile.

The next thing you know we might have another Omni size acquisition come along, or we could have a whole bunch of little acquisitions in different areas that we're working on.

Right.

No, the color is very helpful.

I had a second question.

You mentioned some of the legal, or some of the costs associated with the campaign by UNITE HERE in particular, and it appears that there are a number of contracts that are coming up for renewal in the lodging industry in 2006 where UNITE HERE is potentially going to be putting a lot of pressure on lodging customers.

So I just wanted to get a sense of, I know that they typically will try to include some component of the use of uniforms and who the supplier of uniforms is for a specific hotel.

I was wondering if you've had any experience where you might have lost business as a result of a specific Union campaign, and just any thoughts you might have on any potential risks there in 2006.

I'm not aware of any losses that we've had, and I'm not concerned about it.

Okay.

All right.

Thank you.

And next from William Blair we'll go to Bruce Simpson.

Good morning.

Hi, Bruce.

If we add back the impact on gross margins and pull that down through the operating margin line on the hurricane, it sort of feels like we're over the last year and a half at a normalized operating margin level of about 16%.

It's actually been quite constant on a year-over-year basis for the last two or three fiscal years, and a net income margin of maybe between low and high 9's.

And I think I've heard you say in the past, Bill, that the total target for profitability is a net income margin of between 10 and 11.

Yes.

So my question is, is there any reason to think that that target should be changed, either up or down?

Is there any way for you to help us understand when you think that might be sustainable, that you might crest up above 10% in net income margins?

I would have done it this quarter had it not been for the unusual events.

We were there.

And so, therefore, I'm confident that, again, if we could get energy costs back to at least a little bit more reasonable level, with the other initiatives that we have going on, I think that it is very much going to be in the 10 to 11% range.

We're still very comfortable with that target.

So looking forward, should we be thinking about maybe 3% as kind of the standard bogey for energy as a percentage of sales?

I mean, I know that this quarter was extraordinary.

On the other hand there's reason to believe we're never going back to gas at $1.80.

I agree.

I don't know, Bruce.

I read different things.

I sure hope we can get back down to the 2.8 to 3% level, and I think if we can, we will be able to achieve our 10 to 11%.

Okay.

Now, I want to say this again for all of the analysts, that keep in mind, as you look at your quarters, next quarter is a 64-day quarter, and, therefore, even if everything got back to normal you're going to be a little lower margins in the third quarter than will you be in the fourth quarter.

So I think that people need to factor that in as they do their estimates.

We're not going to provide quarterly guidance, but I think you all need to do that if that's what you're going to do.

Bill, when you talked about passing through the higher energy costs, now is that in the form -- have you implemented anywhere in the country a specific surcharge, or is it just sort of being a tad more aggressive in terms but staying within the normal contractual vehicle?

Well, I don't think it's being more aggressive.

I think it's following our contracts with our customers and implementing price increases where we're allowed to increase them in accordance with the contracts.

Okay.

Thanks.

And my last question just has to do with pacing of organic growth.

We've had an impressive and a consistent increase in the rate of organic growth in the rental business really for two to two and a half years, although the last three-quarters feels like kind of right around 8%, and I know you got dinged by the hurricane this time, but even so if it was 8.5, it begins to feel the rate of acceleration in organic growth might be slowing a little.

Is that reasonable?

And where would you think -- if we're going to go from 8, 8.5 to where you think you can get to, to low to mid teens, which specific component of organic growth do you think is going to pull it up?

I think all four components are going to contribute to our ability to get back to double digit organic growth.

We're seeing the, as you know, we're seeing the acceleration in the new business line.

We're seeing nice increases, nice improvement in the price increases.

We think that we can get the lost business and the add/stop -- of course, add/stops are, as you know, Bruce, we can't control that, but the lost business, we feel that we can make some improvement on that.

So all four components in our mind will contribute to getting to the double-digit growth rate.

Do you think that the add/stop is benefiting more from cross sale of non uniform items or from head count improvement among uniform wearers?

It's definitely cross sell right now.

The headcount, as I mentioned before, did turn positive in the month of November, but the story amongst -- the big story behind add/stops is truly in the cross selling of the bulk products to our existing customers.

And is mats the big majority of what's being cross sold at this point?

Well, I wouldn't say it's the vast majority.

It's definitely a product line that we like and our customers like and we've shown our uniquenesses in manufacturing those mats with our partner but also the rest room services are a big area for us.

Our people are rallying behind that product line, our customers like it.

They're definitely looking at it as an outsourcing theme for their companies because they don't have time to take care of it themselves.

So all of the products and services within that facility service area are contributing to that positive momentum.

Okay.

Then last thing, is just on share count, I was a little surprised to see it sequentially tick up.

Is that just a function of where the share price closed the quarter, and what's the philosophy about share repurchases?

Are you actively trying to lower it or are you just sort of offsetting option creep?

Well, first of all, when you go to calculate diluted shares, you have to use the current stock price to -- under the treasury stock method, and without getting into technicalities, that's what made that share number increase during the quarter.

Because shares did not -- total shares outstanding didn't change, but the diluted share impact did change, and it's a function of the price of our stock.

As to the question on the share buyback, the Company continues to evaluate the opportunities of buying back its shares at -- relative to other opportunities it might have, either now or in the future for its cash, and we have the program actively monitoring it with the Board's oversight continually.

Okay.

Thanks.

And next we'll go to Greg Halter with Great Lakes Review.

Good morning, guys.

Hello, Greg.

Question regarding energy.

And I know you've indicated in the past that you don't do anything in the hedging area.

Is that something that could change, or is it really the pricing side where you're trying to take a look at that as maybe an alternative?

We have decided not to do hedging at this time, obviously given the prices.

In the future it will be a program that we will continue to evaluate and determine whether or not it would make sense for us to do so.

But again, as we've spoken about this before, while energy costs have had an impact on us and are over 3% of our revenues, it's still not like what the airlines face when they have a much higher percentage of their revenues.

But if we found that it would be beneficial to our shareholders we would certainly consider doing something.

Okay.

And--.

Greg, if I could add to that we do have a Six Sigma initiative looking at our costs that we're incurring in the energy area, especially as it relates to the fuel costs for the truck fleet, and we're looking at some initiatives to try to save money on that spend by looking at some different tools for how we purchase fuel.

So it's not a hedging program, as Bill said, but it is a cost savings initiative that we are spearheading through the Six Sigma area.

Okay.

And do you have the allowance for doubtful account figure at the end of the quarter?

Yes, I do.

Hold on one second.

The allowance for doubtful accounts at the end of the quarter was 15.4 million roughly.

Okay.

And just a question regarding systems.

Do you have any ERP systems that are about to be put into place?

No.

Okay.

Good.

I mean, yes, I -- no.

Just taking a quick look at that allowance, it's up from 12.8 in the first quarter.

Anything driving that, or is that more hurricane driven?

No, I think Karen mentioned that in her comments.

There were a few factors there with the hurricane impacted areas as well as we just think kind of a slowdown in some payment practices on people as they were fighting other cost increases in their businesses, but we're not concerned with that going forward.

We think it should be back to comp levels that we were experiencing before by the end of the fiscal year.

Okay.

One last one.

I know you've been ex experimenting, I think in the Mason facility with the RFID.

Just wondered if you could briefly comment on what you're seeing out of that effort.

Really, not much more than I can say.

We're still in the process of testing and evaluating it.

We have not rolled it into any other locations at this time nor have we made a decision whether we will or not.

It's still being evaluated.

Okay, thank you.

[OPERATOR INSTRUCTIONS] Moving on, from Citigroup we'll hear from Pete Cirillo.

Hi, guys how are you doing?

Hi, Pete.

Couple quick questions.

A couple housekeeping actually.

Operating margin for each division, I don't know if I missed that on the call, can you give that real quickly?

Pete, I don't have that readily available specifically but when I took -- I took a look at that and it's comparable to what the operating margins were for the two segments in the first quarter.

Okay. 18.5, low 8%, in that range?

Correct.

Okay.

Second is, just quickly on the acquisitions, you've done 87 million I guess, year to date, so should we be thinking something like double that, or is that a little bit aggressive for the year?

Well, as I mentioned earlier, I think with Michel, I really can't predict that, Pete.

It is so much a factor of the sellers, and while we have discussions going on, I just can't control their timing.

All I can tell you is that it's more active now than it has been before, and hopefully we'll see more closures of deals.

I mean, in terms of the document management acquisition, their shredding, whatever, how many -- can you tell us how many you've done sort of in the last 12 months or last, since you've gotten into business last couple of years, how many you've done in total?

Well, no, I don't have that number with me but it's been a lot.

They're mostly small acquisitions.

Any idea sort of what the targets are?

Do you guys tend to look at a sort of revenue multiple, or what's the criteria for when you find one you like?

I'm not going to talk about that.

We look at it on a return for our shareholders, and I don't want to set an expectation out there.

There's a lot of people listen to this call, and every deal is negotiated on its own based on the economics of the deal.

In terms of organic growth, the figures that you gave for other services, can you just real quickly say them again with and without the hurricane effect?

I'm not sure if I got one for each.

And you're talking about other services revenue.

Yes, because I plugged your figures in.

I think 6.3, 12, and 43, and it was more than 9%.

Yes.

The 6.3 was with the hurricane impact in the national accounts sales division.

Without that it was around 8%.

The 12% for the first aid and safety division and fire protection services is roughly the same without the hurricanes.

Okay.

And the 43% for the document management division really would have ratcheted up to 46% without hurricanes.

Last question is, interest income, it fell a bit, and I guess it's -- I'm assuming it sort of stabilized at this point because cash didn't change much this quarter?

Well, the net interest was impacted by the share repurchase program.

We had borrowed some money -- we utilized some cash, we also borrowed some money from our CP program, so the changes from the first quarter, which weren't dramatic, actually net interest, was comparable to the first quarter, but--.

If you break it out to the actual interest income line though you can see a bit of a difference.

Yes, and that was entirely attributed to the share repurchase program.

Okay.

So -- okay.

I got you.

Great.

Thanks a lot.

And next we'll go to Brandt Sakakeeny with Deutsche Bank.

Hi this is Adrianne Colby for Brandt.

I was wondering if could you give us a quick update on what you're seeing in terms of the competitive landscape particularly in the other services line?

Well, the other services line is, again, made up of three major segments.

The national accounts sales division is the biggest segment within -- biggest division within that segment.

Their performance, as you can see from the organic growth rates is nicely positive.

Recall that a lot of their customers, or the hotel, the lodging, the casinos, the cruise ships, and in spite of the hurricanes, still performed very nicely.

So from a competitive landscape, I would say that they are, of course, we all have -- each division has competition, but from a competitive landscape that division is doing extremely well, and I would attribute that to the fact that we have such uniquenesses in our product line.

We have our design capabilities, we have a very impressive distribution system in our Chicago headquarters, and we're able to compete very well in that division.

The other divisions, we certainly have competition, first aid and safety is primarily a lot of local competitors, in the document management there's one very large operator, or a couple very large operators in document management and many small operators, so competition is strong in all groups, but we continue to have a lot of new business wins.

And what about in the clean room?

Have you seen much in the way of new entrants there?

No, I haven't seen any new entrants at all.

I know that you had mentioned that the overlap with uniforms in the clean room business was not quite at the same levels you'd seen with the mat business.

Has that started to tick up at all?

I don't recall us commenting on any overlap in the clean room business.

Okay.

I must have that written down some place.

Could you comment on the tax rate?

It looked like it crept up a little above 37%.

Should we be thinking about that sort of the same level for the full year, or around 37?

As we've talked about this before in prior calls, we expected our tax rate to be at 37.3% for this year and going forward.

Great.

Thank you very much.

Next we'll go to R. W. Baird and Michael Schneider.

Good morning.

Hi, Michael.

Want to focus just on SG&A.

I believe you guys said that the SG&A was approximately 25 basis points up due to the hurricanes.

Is that an actual dollar out of pocket expense or are you calculating somewhat of an underabsorption rate to get that 25 basis points?

It's primarily underabsorption rate, but there were some additional costs in there, too.

Okay.

And then looking at Q3 and Q4, what have you rolled in or modeled for some of these unusual items?

Are there further write-offs?

Have you worked in any additional severance expenses or cleanup expenses related to the hurricanes that we should keep in mind?

I don't know what you mean by severance expenses.

We didn't have any severance expenses.

All of our operations are back up and running.

What we did, we paid all of our employees throughout the time that they were shut down or they weren't able to be working.

As far as modeling additional costs, no, we're pretty much continuing to rebuild our businesses in the impacted areas, and our plan is hopefully to get those back up to levels that were at least close to what we saw prior to the hurricane but all that is dependent upon when that business resumes.

Again, the most impacted operation continues to be New Orleans and to a lesser extent Gulfport, Mississippi, then in our NASD business, or national account business in the casinos and lodging throughout the Gulf Coast.

And as far as the airline write-offs go, are you fully reserved in your eyes right now?

Well, our receivables are fully reserved for the airlines that have been bankrupt at this point.

We still have inventory but we are comfortable that they will need to continue to utilize that inventory, and we're selling it to them under a preferred vendor arrangement right now, so it guarantees that we will get payment for that.

If they should go out of business totally, there might still be some exposure on the inventory side if we can't dispose of it in another way.

Okay.

And then, Karen, to repeat, you had said operating margin probably similar, 18.5% for the rental division?

Right.

Okay.

Well, to me that's the most encouraging thing in the call, because if you back into the SG&A then, the surprise to me is to hear that for the first time really in, well, I'll call it seven or eight quarters, you guys did show SG&A leverage in the rental division despite the hurricane underabsorption.

Yes, Michael, I think you're right about that.

Again, the way we calculated that 25 basis points was strictly to say if you took the $6 million that we lost, and assuming that that would have been on the top line, that SG&A margin would have gone down by roughly 25 basis points.

So the only thing that we don't have that broken down for you is the breakdown between rental and other services revenue.

Right.

But you're right.

Well, no, but let me comment.

There were some additional costs that we had, as we were helping out some facilities that were in SG&A, but that's, as I said earlier, that was lesser impact than the fact of lower revenues.

Exactly.

But my point is, this is what we've been waiting for.

We've been waiting for you guys to show SG&A leverage, and the fact that you did it in a quarter with the brunt of several hurricanes is something to be excited about.

Or is there something I'm missing here?

No, Michael, I think you're right.

I appreciate you saying that.

We feel the quarter actually was a good result relative to the fact of the energy and the hurricane impact, which energy is really the hurricane impact, so we were at a 10% plus net margin as a result of all this, if you factor those things out.

So we are seeing leverage.

We continue to see growth.

And we were very encouraged by the trends that we saw.

I think the disappointment was that some of the analysts did not lower their expectations for the quarter, and so as a result, the press is out there that we missed analyst expectations.

Well, yes, we did, but the fact is that several people never lowered the numbers to take into account the two issues we just talked about, which had a major impact on us but we think are hopefully more of a one-time event.

Very good point.

And I guess just switching topics a bit to the add/stop rate, Karen, do you have any sense -- I presume that uniform add/stop rate is negative more so than the average of minus one point.

Can you give us some range as to what uniform is running versus ancillary?

Because I guess I'm also curious is ancillary actually in positive territory?

I wish I could do that for you but unfortunately during this quarter the amount of stop orders that were written in the hurricane impacted areas is distorting that add/stop number.

So if I were able -- I can't give you a clean add/stop number without the impact of the hurricanes.

Do you sense, though, just intuitively when you look across the other regions, ex the southeast, is the ancillary add/stop rate actually in positive territory, or are they both negative?

Yes, it is in the positive territory and it's also reflective of going into the winter months when that business does pick up.

And that's the mats in the schools?

Schools, but you also have the winter weather causes people to use mats more frequently, or there's more volume of mat business during the winter months.

Right.

So I wish I could tell you what the number is for just uniforms alone, but I just don't have a good number right now, knowing that it's been impacted by this aberration from the hurricanes.

Okay.

And then just one follow-up on the interest expense.

Were there any fees associated with unwinding the swap and/or prepaying the short-term debt in the quarter that would have explained some of the spike in the interest expense?

No, there were no fees to unwind the swap to speak of.

We pretty much got out of that instrument on a break-even basis, and nothing abnormal about the CP borrowings for the stock repurchase program.

Okay.

Thanks.

And happy holidays.

Thank you.

Same to you.

And Mr. Gale, there are no further questions.

I'd like to turn the conference back to you for any additional or closing remarks.

Well, the only additional comment I would like to do is add to -- on behalf of Cintas, to all of you and your families, a very happy and joyous holiday season.

Again, we are very pleased that you joined us today.

We hope that we didn't inconvenience any of you by doing it in the morning but we had a lot of requests to do so rather than do it tonight after the market closed.

So hopefully many of you can enjoy the holidays and get an early start.

But thank you for joining us, and we'll look forward to speaking to you again in March.

And that does conclude today's conference.

We do thank you for your participation.