信達思 (CTAS) 2009 Q2 法說會逐字稿

Good day, everyone.

Welcome to the Cintas quarterly earnings results conference call.

Today's call is being recorded.

At this time I would like to turn the call over to Mr.

Bill Gale, Senior Vice President of Finance and Chief Financial Officer.

Please go ahead, sir.

Good morning.

Thank you for joining us today to discuss our second quarter fiscal 2009 results.

Joining me is Mike Thompson, our Vice President and Treasurer.

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

For the quarter ending November 30, 2008, total revenue was $985.2 million, a slight increase over the second quarter last year.

The current economic slowdown impacted all of our business segments.

We saw especially weak results in the sale of uniforms to the hospitality industry and also saw weakness in uniform rental as our customers reduced headcount or shut down facilities.

Additionally our rental revenues were negatively impacted by the rapid decrease in the value of the Canadian dollar and the impact of the September Gulf Coast hurricanes.

Net income was $71.8 million, down from last years $82.9 million.

Higher cost of energy, hangers, and employee medical expenses coupled with the rapid deterioration in revenues all contributed to the disappointing net income.

Additionally this years results were negatively impacted by a higher effective tax rate of 39.4% versus last years 38.3%.

With the adoption of the new rules on tax accounting, companies must be more precise on a quarterly basis in the recording of the tax provision versus the old rules which calculated taxes on an effective rate for the entire year.

This quarters higher tax rate should be the highest of the year.

By the end of the year, we expect our rate for the entire year to be 37.1%.

Shortly, Mike will provide you further details regarding growth by segment as well as a discussion of margins.

During the quarter, the Company paid down approximately $80 million in commercial paper through aggressive management of capital spending and acquisitions.

We will continue to focus on cash generation in order to take advantage of growth opportunities over the next few years as financial conditions improve.

Due to the uncertainties that exist in the economy, we must remove the previous guidance we provided for the fiscal year ending May 31, 2009.

We are unable to determine the severity or length of the recession and believe that any guidance we would provide would be subject to too much risk and therefore, not meaningful.

We recognize our obligation to our shareholders to manage our costs aggressively and are taking steps necessary to adjust to the new revenue levels.

In addition, we will continue to focus on providing our customers with exceptional service.

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 would now like to turn the call over to Mike Thompson for additional commentary.

Thanks, Bill, and good morning.

Total revenues were $985.2 million for our second quarter, a $1.3 million increase over the $983.9 million reported for the second quarter of fiscal 2008.

As mentioned in our earnings release and by Bill, the current economic environment continues to impact our revenue.

In addition the weakening of the Canadian dollar and impact of the September hurricanes reduced our revenue growth rate by approximately 1% for the quarter.

This year's second quarter had the same number of workdays as the second quarter of last year; however this years first quarter had one less workday than the first quarter of fiscal 2008.

Therefore our six-month year-to-date results reflect one less workday in the same six-month reporting period last fiscal year.

Year-to-date revenue growth for the six-month ended November 30, 2008, was 2.5% on a comparable workday basis.

Total Company internal growth was negative 0.7% for the quarter.

Year-to-date internal growth was 1.6%.

The remaining two quarters of fiscal 2009 will each have the same number of workdays, 65, as each of the last two quarters of fiscal 2008.

Accordingly, fiscal 2009 will have 260 total workdays, one less than the 261 workdays last fiscal year.

The number of workdays does have an impact on both revenue and income.

As a reminder we classify our businesses into four reportable operating segments.

Rental uniforms and ancillary products, uniform direct sales, first aid safety and fire protection services and document Management services.

Uniform direct sales, first aid safety and fire protection services, and document management services are combined and presented as other services on the face of the income statement.

Details for these operating segments is provided in the supplemental segment data included in the release.

The rental uniforms and ancillary products operating segment consists of the rental and servicing of uniforms and other garments, mats, mops, shop towels and other related items.

Our restroom and hygiene products and other related services are included within the segment.

We are the largest uniform rental Company in North America and have significant geographic coverage giving us the ability to reach approximately 95% of the workforce in US and Canada with our existing infrastructure.

Rental revenues were $711.5 million for the quarter, compared to $708.8 million in the second quarter last year, a 0.4% increase.

Internal growth for the segment was 0.4% as well.

As with the Company in total, the significant weakening of the Canadian dollar and the Gulf Coast hurricanes during the quarter also had a negative impact on our rentals revenue growth rate by approximately 1%.

If the current US to Canada exchange rate remains at its current level for the rest of fiscal 2009, we expect our revenue growth rates in the third and fourth quarters to be negatively impacted by approximately 1%.

As mentioned, business conditions deteriorated further during our second quarter.

The US economy has lost approximately 2 million jobs so far this year and the national unemployment rate rose to 6.7% in November, the highest level since 1993.

While these conditions have affected revenue from all of our rental products and services, our uniform business has been impacted the most, experiencing slightly negative internal growth during the quarter.

As with last quarter, the most significant impact on rental revenue has been through our add stop metric, as many existing customers are being forced to reduce headcount and close or consolidate existing facilities.

During our first quarter earnings call, we indicated our new business results began to be impacted by the economic environment.

Our second quarter new business results weakened further as prospects became more reluctant to add new services given current economic uncertainties.

While our loss business increased slightly during the quarter, this was mainly due to customers going out of business or not paying their bills timely.

We have continued to do a solid job overall and maintaining our existing customer base.

Price increases, while also affected during the quarter, have held up relatively well.

While our growth metrics suffered, we are encouraged with our customer retention results.

Many of our existing customers are reducing staff and locations but overall, they continue to retain our services, understanding and appreciating the value our products and services provide them.

This high customer retention provides us a solid foundation for when conditions improve.

Our other services revenue, which includes our uniform direct sales, first aid safety and fire protection, and document management segments declined 0.5% for the quarter.

Internal growth was negative 3.5%.

Other services incorporates our uniform direct sales, first aid, fire, and protection services, and document management services operating segments.

Other services revenues were significantly impacted by lower revenue from uniform direct sales.

Our uniform direct sales operating segment includes the direct sale of uniforms, branded promotional products, and other related products to national and large regional customers to our global accounts and strategic markets division, and the direct sale of uniforms and related products to local customers that typically also rent products from us including items sold through our direct sale catalog.

We're the largest provider of uniforms and related ancillary products in North America.

The uniform direct sales operating segment has been significantly impacted by the current economic environment.

Experiencing a 10.7% reduction in revenues.

There have been no recent acquisitions within this division so this reduction is all internal.

Within this operating segment, our global accounts and strategic markets division suffered substantially declining approximately 15%.

This division services many hospitality and gaming customers.

Many of these customers are delaying purchases, expansion programs, and refresh programs in light of current conditions.

As with customers in our rental division we continue to retain these customers but their purchasing levels have declined.

The direct sale of uniforms and related products to our existing local customers while slightly negative as compared to the second quarter of last year fared better than global accounts.

Within first aid, safety and fire protection services, we sell and deliver first aid products, safety products and automatic defibrillators to our customers and provide safety training to our employees.

We install, inspect, repair and recharge portable fire extinguishers and sprinkler systems.

We also provide and service emergency lighting systems and kitchen fire suppression systems.

We are the largest on site provider of first aid and safety products in North America and the second largest provider of fire protection services.

During the quarter revenues within our first aid, safety and fire protection services operating segment grew 1.3% in total but decreased 0.5% on an organic basis.

The first aid portion of this business continued to grow organically but at reduced levels.

This business is reliant on customer employment levels as much of the revenue is based on product usage within the first aid cabinets.

Training revenue has also been impacted as customers have less employees requiring training and in some cases are reducing or delaying certain training programs.

Fire service internal growth continues to be negatively impacted due to continued difficulty in the fire installation business, reflecting the continued weakness in commercial construction.

While we have reduced our installation business over the last six months, it continues to have an impact on fire results.

Our document management services operating segment is comprised mainly of document shredding services although we do have storage and inventory capabilities.

Service revenues within this operating segment continue to provide strong growth as revenue increased 28.5% for the quarter.

While still strong, this segments growth rate has been slowed by a combination of low recycled paper prices and postponements and/or reductions in customer purchase frequency and volume.

Second quarter paper prices remain slightly higher than paper prices during the second quarter of fiscal 2008 but have come down to approximately 50% of the high mark level reached in March of 2008.

As customers look to save funds, many are requesting a reduction in their shredding service frequency; however as with our other divisions, we are continuing to retain our customers in this segment.

Document management internal growth for the second quarter was 13%.

Excluding the effective paper prices, our shredding revenue internal growth was in the high teens.

Second quarter total Company gross margin was 42.1%, a 60 basis point decline from the second quarter of fiscal 2008 and a 30 basis point decline from this years first quarter.

Energy costs, which have come down steadily and significantly through this fiscal year second quarter, were 3.55% of revenue which was 35 basis points higher than energy costs and last years second quarter.

However, as compared to this years first quarter, energy costs did decrease approximately 80 basis points.

Energy costs came down consistently through the quarter declining approximately 25 basis points each month during the second quarter.

November's energy costs were down to 3.25% of revenue.

While volume usage does fluctuate through the year, if energy pricing remains at current levels, we expect to experience better quarter to quarter comparisons moving forward.

Excluding the energy impact, Company margins were negatively impacted by revenue reductions in uniform direct sales and fire protection services and the reduction in paper prices within document management.

In addition, the Company suffered approximately $1 million in losses related to the September hurricanes and approximately $1 million due to the weakening of the Canadian dollar.

As mentioned in our earnings release we're actively managing our cost structure, eliminating all non-value-added work and challenging our cost structure.

As an example, over the last few months, in anticipation of deteriorating economic conditions, we have reduced our total Company workforce by over 5%.

This reduction has occurred over time as we are stringently analyzing all new and replacement hiring.

The full benefit of this reduction is yet to be seen through our financial statements.

In addition, the 5% headcount reduction does not reflect the recent closing of two manufacturing plants which we announced in early December.

We are also challenging route structures and have consolidated what we call growth routes.

That is routes in most operations that previously maintain capacity for growth.

While we look to continue to grow, we have and will continue to consolidate routes in order to properly reflect current market opportunities.

We also are analyzing better production processes and equipment which we believe will have a positive impact on our operational cost structure in the future.

Our rental gross margins were 43.6% of revenue for the quarter, a 110 basis point decline from last years second quarter, but a 10 basis point improvement from this years first quarter of fiscal 2009.

Energy costs increased over $2 million or approximately 30 basis points over last years second quarter.

In addition, other commodity costs increased approximately 60 basis points with an increase in hanger expense alone of approximately $3 million or 40 basis points as compared to last year.

As we mentioned last quarter, hanger costs increased significantly earlier in calendar 2008 as the US imposed a significant tariff on hangers produced in China, where we source the majority of our hangers and also due to the volatility in steel prices.

Other commodity costs which increased include water usage, and wash and water treatment solutions.

Losses related to the hurricanes and weakening Canadian dollar impacted margins by a combined approximately $2 million or 30 basis points.

Certain other cost increases including an increase in material costs due to increased prices in restroom paper products we sell and service to our customers were offset by operational efficiencies.

Rental margins improved from our first quarter as the segment benefited from the improvement in energy costs.

The energy cost benefit was partially offset by the hurricane impact, the weaker Canadian dollar and lower revenues compared to the first quarter.

Other services gross margin was 38.4%, a 60 basis point improvement from the second quarter of fiscal 2008 but a 110 basis point decrease from the first quarter.

The improvement from last years second quarter was mainly due to sales mix, as the more profitable first aid safety and fire protection services and document management operating segments continue to grow faster than uniform direct sales, and therefore, pulled margins up.

Margins improved over last year despite energy costs being higher this year than last, and the current revenue headwinds, especially those in uniform direct sales.

Higher energy costs were the main factor in driving document management margins lower as compared to last year while improvements in streamlining our fire operations, especially our fire installation business provided healthy margin improvement in first aid, safety and fire despite the energy cost increase.

The margin decrease is compared to the first quarter was from the revenue shortfall and uniform direct sale and first aid safety and fire and the significant decrease in paper prices and reduced processing tonnage within document management.

Selling and administrative expenses were 28.9% of revenue as compared to 28% for last years second quarter and 28.7% in this years first quarter.

The increase from last year was a substantial increase in medical costs due to an increase in the number of claims.

Medical costs have been high for two quarters; however based on more recent trends and the recent headcount reductions, we believe medical costs should come back to more historical levels.

Bad debt expense also increased over the prior year as customers continue to struggle with the effects of the economy.

The small increase from the first quarter was due to lower than anticipated revenue for the quarter.

Net interest cost this quarter was $12 million, the same as net interest for our first quarter of this year.

Our effective tax rate was 39.4% for the quarter as compared to 38.3% for the second quarter of last year, reflecting reserve requirements under FIN48.

Under FIN48 the effective tax rate will fluctuate with reserve requirements on a quarterly basis, impacting quarterly net income and earnings per share results; however we continue to expect our effective tax rate for fiscal 2009 to be approximately 37.1%.

To reach this level our effective tax rate for the remainder of the year will be below 36%.

We expect that due to the timing of reserve requirements and releases under FIN48, our year-to-date effective tax rate at the end of the third quarter will actually be below 37.1% and will then increase slightly in the fourth quarter to reach the 37.1% effective rate for the year.

For the quarter net income was $71.8 million, and earnings per diluted share were $0.47.

Had our effective tax rate during the second quarter been 37.1% as we expected to be for the full fiscal year, net income would have been approximately$74.5 million and diluted earnings per share would have been $0.49.

Our balance sheet continues to be strong.

Our current ratio improved to 3.8 to 1 at November 30.

We have approximately $127 million in cash and marketable securities.

A majority of our marketable securities are invested in highly rated short-term Canadian government securities.

Our cash position at the end of November was reduced as compared to August 31, as we took advantage of US tax law changes and accessed approximately $50 million in US dollars of our Canadian funds.

These funds were used to reduce our outstanding commercial paper borrowings.

We continue to target Canadian funds to be used for future international expansion.

Our DSOs on receivables increased from 44 at the end of the first quarter to 46.

This increase was due to a combination of slower paying customers and also the impact of the last day of November falling on the Friday after Thanksgiving which had an impact on collections at the end of the month.

Our inventory levels have increased approximately $13 million over November 30, of 2007, due to the opening of a new facility services distribution center which we discussed last quarter.

Excluding the inventory build to bring this facility online, new bids inventory for the Company decreased approximately $3 million.

Our accrued liabilities increased approximately $15 million over November 30, 2007, mainly due to the elimination of our VEBA account which historically was used to prefund employee medical costs.

A change in tax code eliminated the benefit of maintaining VEBA.

The VEBA trust was therefore terminated and claims are paid directly out of cash.

In addition to the VEBA, accrued liabilities were higher due to an increase in accrued bond interest relating to our 10 year bond offering which was issued in December of 2007.

A reduction in real estate accruals offset much of this increase.

Our current income taxes payable is actually a prepay as of November 30.

We presented this prepaid as a so-called negative liability on the balance sheet in order to highlight the change.

Last year we had a $72 million payable and this year we have an $8 million prepaid.

New requirements to finding how quarterly estimated federal tax payments are computed and made have gone into effect.

Additionally, as I mentioned previously, the Company used a VEBA trust in the past to prefund employee medical costs.

The tax advantage of these trusts was eliminated resulting in higher estimated tax payments earlier in the current fiscal year.

Long term debt at November 30, 2008, was $871 million, a reduction of approximately $80 million from August 31.

The reduction occurred despite the increased estimated tax payment requirements but benefited from the Canadian cash usage discussed earlier.

Total debt as a percentage of total book capitalization improved from 29.3% at August 31 down to 27.2%.

The majority of our debt is in long term fixed public debt.

At November 30, we had $83 million in outstanding CP which is included in our long term debt.

Using our credit facility, we have been able to receive regular funding under our program for attractive rates.

Our cash flow remains strong.

Despite the required change in estimated tax payments previously mentioned, our year-to-date cash provided by operations was $175 million.

Our capital expenditures were $41 million in the second quarter and $96 million year-to-date.

We are implementing SAP for our financials and our supply chain and we upgraded computer equipment in the field, which has kept our CapEx in total about flat through six months of this year as compared to last year.

While we continue to move ahead with the SAP implementation, we are challenging all capital expenditures, raising our return expectations and scruitinizing assumptions on all investments.

Because of this, we have reduced our expected CapEx needs for the year and now believe that we will be between 150 million and $170 million.

We spent approximately $6 million during the quarter acquiring a few small businesses mainly in document management.

We continue to be very selective in our approach to acquisitions.

Ensuring that the required investment is appropriate.

The acquisition pipeline continues to remain active mainly with smaller businesses and our emerging business units.

We remain very interested in using our capital to make strategic acquisitions but only at appropriate valuations.

In summary, like most companies, our business is currently being pressured by external economic factors.

We are actively and aggressively challenging our cost structure and expect to gain benefit from these improvements as well as from lower energy and other costs.

We firmly believe that our strong position and all of our lines of business combined with our conservative balance sheet position, strong cash flow, and manageable debt service level will provide a significant opportunities as we move through and out of this challenging environment.

We appreciate your time and thank you for being on this call.

Bill and I would now be happy to answer any questions you may have.

Thank you, Mr.

Thompson.

(Operator Instructions) At this time our first question comes from Andrea Wirth with Robert W.

Baird.

Good morning, Bill and Mike.

Good morning.

Wondering if you could just first address, you call out in the press release specifically the $14.5 million higher costs associated with commodity costs and the hurricanes, et cetera.

How much of that $14.5 million was actually already in your guidance or essentially how much actually came in greater than you had expected?

Oh, Andrea, I would say the hurricanes and Canadian dollar probably were not quite as much included in there but we did assume kind of energy cost at levels that were comparable to the first quarter going forward through the year.

Hanger costs we certainly had seen that increase last year so that was pretty much in our guidance.

The major problem that we talked about was the rapid deterioration in the revenue line which makes, it's very difficult to adjust your cost structure that quickly and that's what we are aggressively doing but we're concerned about what's going to happen with the revenue going forward, so that's why we can't give guidance at this point.

Sure, no, I understand that.

I guess I was just trying to understand it in terms of just your cost side of things especially as it relates to that $14.5 million, what was actually greater than expected?

Andrea certainly the medical costs were higher than we anticipated for the year.

Okay.

So it fair that maybe half of that $14.5 million was actually greater than you had originally expected?

I would say that's right.

Okay, great.

And then just wondering, in the document management business , your margins came down at least sequentially from about 13.5 to 9.6.

Is it fair to say that that's probably all related to lower scrap paper volume just because actually energy costs should have been better

Not all of it.

I would say the majority of it but certainly some of it was based on volumes as some customers reduce their frequency of service but yes the paper price was the majority.

Just trying to understand the magnitude of where margins can go.

I know you don't want to give too much guidance but just given that scrap paper prices continually come down is it probably fair to say margins probably continue to come down sequentially just given the environment holding everything else steady?

We have a floor on our paper price contract, so I don't think you're going to see substantial impact of paper prices from the pricing standpoint.

What we're going to, what our concern would be would be more the volume.

So you think that margins actually should be able to generally, assuming volumes hold?

Well, volumes will be the key to it, and it's just impossible for me to predict volumes at this point.

Okay.

And then just looking on the energy side of the equation, just in terms of what had you been doing with your customers in terms of trying to recoup some of the higher fuel costs going back over the last year.

Was it generally in the form of higher prices, was it fuel surcharges?

And then my next question will be essentially are you having customers coming back to you asking for some price relief on that front?

It was primarily through the mechanism in our contracts of CPI price increases that we were able to pass along, some of our cost increases, although they tend to lag because they are only done on an annual basis.

We don't typically do just fuel surcharges so to answer your question are customers coming back to us?

Not necessarily because the way it works is through the CPI increases.

Now CPI changes that will get reflected in the annual price changes in the contract.

Okay, so essentially the way we should be looking at this is as contracts come up for renewal on an annual basis and that's staggered throughout the year that you may have to take prices back a little bit with CPI being adjusted but other than that we shouldn't expect a wholesale drop in prices?

Right.

Okay, great.

And then just wondering if you could just give us a little bit of thoughts on what your field reps are telling you in terms of just the environment.

Are things expected to get materially worse in terms of add stops?

Especially we're hearing quite a bit about January especially could be a very difficult month.

Just want to get some color as to what your field reps are telling you.

Well, it varies by business unit Andrea.

I would say there's a lot of caution out there among our customers and our prospects because no one seems to know what's going to happen and I think it's almost a frozen mentality saying, you know what?

We really don't want to commit to any additional costs right now because we're not sure how bad things are going to get.

We also are concerned about how many plants which are being shut down here over the Christmas and New Years break are going to open up back right at the beginning of January, there probably will be some delays with regard to that so our reps really probably don't know much more than what you're reading in the paper every day but obviously every day that goes by and you see more closures and more reductions in headcount, that's concerning going forward.

Okay, great.

Thank you.

Our next question comes from Ashwin Shirvaikar.

Please go ahead.

Hi, Bill and Mike.

Hi, Ashwin.

Yes, my first question is the steps that you're taking to adjust to the new level of revenues in shutting down plants, lower headcount, could you help quantify and/or give some impact on timing of the benefit from it?

Well, as Mike told you, we have reduced our headcount over the last several months by 5% overall in the Company and we continue to aggressively challenge any new hires or any replacement hires, so I think that that benefit will start to play itself out here in the second half of our fiscal year.

We did announce in December the shut down of two manufacturing plants in the State of Kentucky which will have an impact more so next fiscal year but will be the cost of that shut down will be pretty much offset by the savings associated with this fiscal year.

The other things that we're doing are just looking at all of the expenditures that we're making in the Company and making sure that they are required to continue to obviously provide the customers the service levels that they expect and make sure they understand the value of the product offerings we're giving them but any discretionary expenditure that can be delayed is obviously being delayed.

Any capital as Mike indicated to you is being delayed, so we don't need to expand our capacity right now because of the volume level, and a significant opportunity will exist as we're able to consolidate routes as volume drops on routes, it's not a quick thing to do but we will consolidate routes and eliminate those that are excess so that we can maximize the volumes that on our routes and that will continue in earnest as we go forward over the next several months.

So we believe that we can reduce our overall cost of doing business and hopefully, we'll be able to offset the revenue shortfalls that we're seeing from what our original expectations were for this year.

Okay, and I realize that the revenue piece is not all that controllable but what is your assumption?

Is it that the worsening continues for the next couple of quarters?

I mean, how are you planning your business or are you assuming sort of it plateaus out at this level or slightly worse?

Well we've got different scenarios that we're anticipating.

We could see a much more dramatic drop off or we could see kind of a steady situation of what we've seen today, so what we're doing is we're looking at it on an ongoing basis and trying to be as flexible as we can with our cost to adjust to whatever happens, but I'll be honest with you.

I can't predict what's going to happen.

We talk to customers, we read, obviously everything that's in the press and it's just very difficult at this time to predict what is going to happen over the next several months.

Again, as I've mentioned to Andrea, how many plants are not going to reopen here right after the end of the holidays but are going to stay shut down for a period of time?

What's going to happen with the gaming industry throughout the country as they continue to see weakness?

So all of these things we're just going to have to try to be as flexible as we can to react to that lower revenue line by trying to keep our costs under control, and there could be a number of different scenarios that will play out and we'll just try to react accordingly.

As we've done and as I mentioned earlier as well, we're really looking to protect that cash flow that we had which is still strong and by looking at our CapEx expenditures and scrutinizing acquisitions et cetera.

We're doing just that because we want to keep the healthy cash flow and our strong balance sheet maintained.

We actually anticipate right now despite a pretty weak economic environment we'll pay down our commercial paper by the end of the fiscal year so all we will have is all of our term debt, the first tranch of which doesn't come due until 2012, and we believe that is a prudent thing to do at this point in time is to really keep that strong balance sheet and keep our powder dry because as always happens in these downturns we're going to see some great opportunities when we start coming out of it and we will be the strongest Company in our business to take advantage of that.

I think to sum it up, I think we're preparing for the worst but we want to react to the present conditions and we want to be able to service our customers effectively in the meantime so I think the flexibility Bill talked about is very important for us in maintaining that strong balance sheet and cash flow situation.

Absolutely.

That sounds quite prudent.

Now, on the topic of being flexible, is there any appetite in your client base to accept more flexible contracts that maybe pass on some of the variability and commodity costs?

At this point in time, I don't think we've seen much appetite to change our normal contract terms.

Obviously, it becomes more of an opportunity in the non-uniform rental business because those typically have different types of contracts, so but we have to also be prudent in terms of dealing with our customers, they're dealing with a lot of problems too so we look to the long term relationship of our customers and we feel like we'll work with them and they will work with us hopefully to keep both of us in a win-win situation.

And we truly believe with our retention rates have held up well and it just shows that the products and services that we're offering are being appreciated by customers and that we're retaining the customers when the customer is still there but it's at lower volumes because of the financial impact they are seeing through their business.

Okay, a couple of clarifications.

One is did you say the tax rate will continue to decline through the year or did you say it will settle at a lower level?

What will happen is in the third quarter, right now our tax rate is high year-to-date versus where we think we'll be at the end of the year, so to get from where we are today at about 38.3% to the 37.1% for the year, you're actually going to have a rate less than 36% over the last six months.

Most of that correction will occur we expect in Q3 such that the Q4 if you just look at it on a quarterly basis the Q4 effective tax rate is slightly above 37.1 so we believe you'll see a tax rate actually below 37.1 year-to-date through Q3.

Right, okay.

And then the results, they don't include the Labor Department settlement?

That has not happened, correct?

Yes, that announcement that just was made last night, the fine associated with that agreement with OSHA has already been reflected in our financial statements and we're very pleased to get that settlement behind us and we believe that we've got a very good program going forward to make sure that our Operations are safely run and all of the financial impact of the fines have already been reflected.

Okay, thank you guys.

Sure.

Our next question comes from Vance Edelson of Morgan Stanley.

Hi, thanks a lot.

Does the sharp decline in recycled paper prices this year change your appetite at all for investing in that business and is that perhaps one of the best places to reduce investment and reduce expense going forward or do you see an eventual rebound in prices there that would make you want to keep charging forward?

Vance, we see document shredding continuing to be a very good growth vehicle for Cintas.

Obviously, the paper prices are kind of just a series of reactions and over reactions, we think they will settle in somewhat higher but even at these levels that we're seeing right now, we're comfortable that this is a great business.

Again, our margins will continue to improve regardless of paper prices because as we acquire more density and volume and we're spending a lot of money on the selling side to grow that business, it's still a great opportunity for Cintas and we're still very bullish on it.

We got in this business about six years ago and the recent run up in paper prices has really been over the last 18 months and the correction therein.

When we got in this business the paper prices aren't significantly different from where they are today, so not much of a change from that standpoint.

Okay, thanks for that and then in terms of wanting to do smaller strategic acquisitions what are you seeing in terms of private market values?

Have they been on the decline which might make for even more attractive targets out there, isn't that what you're seeing?

I don't think we've seen it yet to the degree it needs to happen in order for us to become very aggressive on acquisitions.

There periodically will come across one and as Mike mentioned we spent a few million dollars in the second quarter but I think there is a shock that's hit a lot of these private companies with the rapid deterioration in valuation, not only for their businesses but just looking in general across the equity markets, so it's going to take a while for their expectations to adjust and we'll be patient waiting for their expectations to get more aligned with economic reality.

Okay, and going back on an earlier point, not to pound away at it too much but given that you expect economic improvement eventually and great opportunities as you put it , could you talk about how much flexibility you really have in aggressively removing additional costs from here and how you're going to balance that in your mind with not wanting to hamper growth on the other side of the

Well, I think that the greatest opportunities we have right now are to efficiently run our route based businesses, so we are very actively looking at ways to improve volume levels on routes so that we can obviously take advantage of that as the economic downturn continues.

Certainly looking at G&A, what can we do to consolidate some of the activities in G&A.

We've got, as Mike mentioned, we have a major project going forward with SAP which we believe will have significant benefits down the road on the way we handle some of our financial systems as well as our global supply chain activities, so we're not slowing down on those type of things.

But it just takes time to get that stuff in place and I think that when we start coming out of this economic downturn we will be a much stronger Company, much more efficiently run and we'll see great margin improvements as you get more volume up on that top line.

And in addition to that we have a significant push of ensuring that everything we do is considered value-added work and that's work that the customer appreciates and is willing to pay for so when we are streamlining businesses and looking at operational efficiencies the key for us is if there's value to the customer and they are willing to pay for it we're going to do it because we can still make a good return on it.

It's taking all of these other processes that build up and ensuring that is everything that we're doing really adding to what the customer appreciates and while it's a concept that you can kind of think negligently about when you put into action, there are a lot of things you can find and we've done that so far by reducing headcount by 5%.

Okay, thanks for the detail.

I appreciate it.

Our next question comes from Gary Bisbee of Barclays Capital.

Please go ahead.

Hi, guys, good morning.

Good morning, Gary.

I guess not to beat this one further but is it realistic to think, I realize it could take a couple quarters to get a lot of these cost initiatives you're working on.

Is it realistic to think you could actually have costs either SG&A or on the cost of goods sold line decline at some point or is it more likely just a more severe slowdown in the growth of the cost?

No.

I think it's realistic to think that they could decline.

We certainly have demonstrated some opportunity, some things there relative to our cost structure but as Mike said we had medical costs kind of ran away from us in the second quarter but the latest trends indicate that that's going to come down to more normal levels.

The impact of this headcount reduction is yet to be felt as we go forward, so no, we're very optimistic that we could see that happen, assuming that something else just doesn't go out of whack somewhere.

You just can't get that immediately as Bill discussed earlier.

There is a little bit of a lag to get these things in place to make up for that loss of revenues but I'd agree with Bill.

Okay.

On the uniform sales business, obviously that's lumpy and it's probably upgrading uniforms for the big global customers is sort of a discretionary spend to get put off but was there anything either in the year ago comparison or that you saw this quarter that could make the magnitude of the drop be somewhat more of a one-time issue or is it totally possible that we could see double digit declines in the top line there for a few quarters?

Well, again I'm having a difficult time predicting what's going to happen but it would not be beyond the realm of possibility that these type of declines could continue because there really was nothing unusual in last years second quarter.

As I stated earlier and as Mike talked about, we just saw a really rapid decline on the part of our customers to purchase these uniforms because it was more of a discretionary spend.

I mean I don't think any of you are surprised if you think about what's happening with some of the big gaming industry, the big gaming companies or even the big hotel chains, they're seeing significant reductions in their employee or their guest traffic and that is basically resulting in them doing everything they can to reduce their cost.

So it will come back and it always does.

I just think it's going to be, we just got to get out of this doldrum here and get the economy moving again and then we'll be better positioned than any of our competitors because we've got the global supply chain.

We've got the capabilities of providing a lot of different products and services that many of the smaller competitors may not be in existence to be able to do when the economy improves.

Okay, and just the last question for me, obviously it looks like energy will be something that will be helpful over the next couple quarters.

What about some of these other commodities and it seems to me, it could be 60, 80, 100 basis points would help easily it seems like for a few quarters but what about this other stuff?

Steel prices and some of the things have come down so are you seeing hanger costs in some of these other commodities that you referenced being up 60 basis points come down at all or is that likely to continue to be a pressure in the near term?

Well, hangers are artificially being escalated because of the government intervention in putting the tariffs on.

We are looking at opportunities to try to diminish the number of hangers that we're using in our facilities to encourage recycling of hangers.

There certainly will be a little bit of an impact because steel prices have come down recently.

Now, with all of the infrastructure projects that are being proposed steel may jump right back up but the big issue is there are no, there are not a lot of viable hanger manufacturers left in the United States and until we find a source that is not subject to the tariffs, I'm not sure you're going to see a lot of impact on hangers.

Now it will anniversary itself in the fourth quarter because that's what we began to first see the increases and hopefully through some of our conservation efforts will minimize the use of hangers but that's one that will probably stay there.

Energy costs certainly are going to, should improve or should continue to provide a benefit going forward.

We won't have the hurricane issue.

I can't predict what's going to happen with exchange rates but boy that rapid increase in the Canadian dollar has already been mitigated a little bit recently so hopefully that won't be an ongoing issue and as Mike mentioned, medical costs certainly we believe can improve going forward based on recent trends.

Okay, well I talked to one of your drivers this morning here who had a truck full of mats getting ready for the snowstorm we're supposed to get.

So hopefully that will happen and drive a little incremental revenue for you.

For our sake hopefully it will happen and for your sake I'm sure it will be more of a hassle.

Definitely.

Thanks guys.

Happy Holiday.

You too.

Our next question comes from Scott Schneeberger of Oppenheimer.

Please go ahead.

Thanks, good morning.

I guess I'd like to ask about the pricing environment you're seeing out there, obviously with the economic pressures and I believe you alluded to a price, a recent pricing increase that had taken well.

If I could just get a little bit more elaboration on this topic, thanks.

What I'd indicated was price increases while a little more difficult in the quarter held up relatively well, so pricing continues to be fairly aggressive in the marketplace , certainly with customers or prospects being very diligent on their financial situations, I'd say price increases have been a little more difficult but overall, considering where the marketplace is we felt that they held up relatively

Okay, thanks, and then you guys have been making a gradual move to some global operations and some verticals that you've alluded to on this call that have been hit pretty hard.

What is the status now obviously with cost constraints?

Are you slowing that effort or is that something that you're still looking to push?

No.

We're still looking to push it.

It's a longer term play, as we've mentioned before.

We see opportunities.

They won't have a material impact in our financials in the short-term, but we still think despite the economic issues that there are great opportunities for us to take some of our services outside of North America and we will continue to pursue those as the right opportunities present themselves.

And again from a capital perspective we're holding a significant amount of dollars in our Canadian operations that we don't repatriate back to the United States for tax reasons, that we really have earmarked for foreign expansion that doesn't affect our debt structure or anything like that.

So it's really looking at the opportunities ensuring that the growth that we're projecting and the cost for that in those countries and in those divisions make sense.

Thanks.

Looking a bit more at the cost side, 5% headcount reduction thus far.

Is that something that you see, we've had a few questions in trying to gauge how much more of that is there to come and how do you want to look coming out of the back side of the economy hopefully in the economic turn, is that something that you are continuing to aggressively do?

It alludes to more to come in the future in the press release.

Yes, there is more to come as we continue to adjust to the economic reality that we have and we're doing that micro managing as I said every replacement hire, every new hire in the Company, to ensure that it's absolutely necessary to create value-added work and provide the service to our customers.

So I think if we don't see the top line begin to grow quickly again, you're going to see more cost reduction through headcount reduction because we will continue to adjust to the economic reality.

And of the headcount reduction we have put in place we haven't seen the full benefit yet.

We didn't have a one set day where we reduced our entire workforce.

It's been based on -- a lot of it has been based on turnover and not replacing that turnover and ensuring that we again evaluate value-added work and ensure that that position needs to be replaced and in many cases we're deciding it doesn't need to be and that's where the 5% is coming from.

Sure, now does that, I guess specifically if I could ask, how are you handling your salesforce?

Is that larger, smaller than it was a quarter ago, and is that, the way you define non-value-added salesforce obviously has a direct touch on customers but if the customers not spending, so are we discussing salesforce as well in that group?

Oh, we absolutely are.

We'll right size the salesforce to reflect what the opportunities are.

There's no group within the Company that does not go without scrutiny and salesforce is certainly part of that.

You got to also understand that we balance out the salesforce among the different opportunities across all divisions, so.

Scott, keep in mind that we were on plan through the first quarter of our fiscal year.

When we talked to you guys in September, and we basically really began to see, we saw a little weakness in August but we really saw it just accelerate as we went through the second quarter, so you got to be careful here.

You don't want to react too quickly but we certainly saw enough during this quarter that said we've got to react because things just continued to deteriorate and we'll see the benefit of that going forward.

It just didn't happen yet in this quarter.

Okay, thanks very much.

I appreciate it.

Our final question comes from Greg Halter of Great Lakes.

Please go ahead.

Yes, good morning.

Good morning.

Hi, Greg.

Relative to the competitive environment out there, specifically surrounding the smaller guys, what are you seeing in that regard?

We are certainly seeing concern on the part of the smaller competitors.

They certainly don't have the same financial wherewithal that we do to continue to provide great services to their customer.

I would tell you, Greg, that if past is indication of future, many of these smaller competitors are going to find it very difficult to continue as a private Company and I think you'll see more consolidation going forward as this economic downturn continues.

Certainly, their access to capital for growth has been hurt pretty severely as it has with many companies, so I'd echo Bill's comments.

Have you seen any of your competitors go out of business yet that you're aware of?

No, no significant competitor yet.

But again, it's early.

While we've been kind of muddling through some economic headwinds throughout most of this year, the real accelerated in our second quarter, so I think it will be another year or so of that before you'll really begin to see real pressure on a lot of these guys.

Okay, and if you look around the country at least in North America, are there any areas that are worse than others and any areas that are better than others if you could kind of lay out the--?

I'd say it's widespread.

We're having more difficulty certainly where most people are, Florida, the Rust Belt, Cleveland area, Detroit, up in those areas, our Northeast is performing a little better, Southwest because of energy is performing a little better, but when I say better I don't mean it's good.

I think across the country it's been hurt.

Southeast with oil at 33 or whatever it is this morning, 38, may not be doing a little better.

Well, that's right and I would say it's a pretty widespread downturn throughout the country and obviously as Mike said some areas are much worse than others and it will be, it's not going to be a good situation for awhile.

And how much is Canada of your business, of your revenues in total?

Less than 10%, so we don't break it out separately.

Okay.

And do you do any hedging on currency at all?

We do some, yes.

We hedged a little bit.

The Canadian dollar weakened so fast that we weren't able to hedge as much as we would have liked at this point in time, but hopefully another opportunity will present itself.

Okay.

And I presume your share repurchase is scrapped for the time being?

Well, let me say this.

We did not buy any shares back in the last quarter and our focus right now is on cash generation and debt reduction.

Okay.

And if tax laws were changed in the US, would you consider repatriating that cash?

Sure.

Absolutely.

Okay.

And one last one.

On your ERP system you mentioned it's going into the financial and one other area and I missed that.

Global supply chain.

Okay.

All right, thank you very much.

Sure.

This concludes our question and answer session.

At this time I would like to turn the conference back over to Mr.

Thompson for any closing additional comments.

Thank you again for participating in today's call and on behalf of all of our Cintas partners, we wish you and your families a very joyous holiday and hopefully a more prosperous 2009.

So we'll look forward to speaking with you again in March.

This concludes today's conference.

We thank you for your participation.

At this time you may now disconnect your line.