信達思 (CTAS) 2012 Q2 法說會逐字稿

Good day, everyone and 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 evening, and thank you for joining us to report our second-quarter results for fiscal 2012.

With me is Mike Hansen, Cintas' Vice President and Treasurer.

After some commentary on the results we will be happy to answer questions.

We are pleased to report that our second-quarter revenue grew 8.8% from last year's second quarter to a record revenue of $1.019 billion.

Net income increased by 33.1% to $74.4 million and earnings per share were $0.57, a 50% increase over last year.

Our operating margin continued to expand as our second-quarter operating margin of 13% was an improvement over both last year's second-quarter operating margin of 10.9% and this year's first-quarter operating margin of 12.6%.

This improvement came despite significantly lower recycled paper prices.

This margin expansion continues to be driven by better capacity utilization, our focus on selling profitable business and controlling our costs, particularly in our general and administrative area.

At our last earnings call in mid-September, we spoke of our cautiousness toward the US economy.

Only about 100,000 jobs had been created during our first fiscal quarter and 2011 and 2012 economic forecasts were worsening while the stock market was declining.

Despite our strong first-quarter results, we were uncertain about how our Business would be affected by the macroenvironment.

Obviously, given this backdrop heading into our second quarter, we have been very pleased to see that our Business continued to be strong throughout this quarter.

While we continue to be cautious regarding the US economy, we do have more confidence about our ability to execute in this less than robust environment.

As a result, we are updating our guidance for fiscal 2012.

We now expect fiscal 2012 revenues to be in the range of $4.075 billion to $4.125 billion, and we expect earnings per diluted share in the range of $2.16 to $2.20.

This guidance assumes no significant changes in the US economy, an effective tax rate of 37% for the entire 2012 fiscal year, assumes recycled paper prices to be approximately $150 per ton, which is our price for November and December, and energy related costs to be approximately 3.5% of revenue.

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 Mike for more details on our Second Quarter.

Thank you, Bill.

As Bill mentioned, total revenue increased 8.8% from the second quarter of last year while total Company organic growth was 7%.

Total Company gross margin for the second quarter was 42.2% which is up from last year's second-quarter gross margin of 41.7%, despite a 20 basis point increase in energy related costs and a steep drop in recycled paper prices.

I will discuss these items in more detail by segment.

Before doing so, let me remind you that there were 65 workdays in our second quarter which is the same as last year.

As a planning note for the remainder of fiscal 2012, we will have 65 workdays in the third quarter and 66 in the fourth quarter.

The total workdays in fiscal 2012 are 262.

We have 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.

The Rental Uniforms and Ancillary Products operating segment consists of the rental and servicing of uniforms, masks, towels and other related items.

The segment also includes restroom supplies and other facility products and services.

Rental Uniforms and Ancillary Products revenue accounted for 71% of Company revenue in the second quarter.

Momentum continued for our rental business.

Second-quarter rental revenue was $722.8 million which is up 9.9% compared to last year's second quarter and up 7.9% organically over last year.

The organic growth rate of 7.9% for the second quarter is an improvement from last quarter's organic growth rate of 7.3% and a very good improvement over last year's second-quarter organic growth rate of 1.9%.

All areas of our Rental business grew in the second quarter.

The less aggressive pricing environment that we saw in the first quarter continued into the second quarter.

Our Rentals segment gross margin was 43.2% for the second quarter, an improvement of 60 basis points over last year's second-quarter gross margin of 42.6%.

Energy related costs as a percent of revenue were consistent with last year's second quarter.

Capacity utilization from higher volumes was the main driver of the improvement.

The second quarter gross margin of 43.2% was slightly lower than the first quarter gross margin of 43.9% but keep in mind that our second quarter had one less workday than the first quarter.

As a result, we have one less revenue day to cover costs that are expensed on a monthly schedule such as material costs, depreciation, and amortization.

One last comment on the Rental gross margin.

The impact of cotton on material cost equaled our expectation.

Our Uniform Direct Sales operating segment includes the direct sale of uniforms, branded promotional products and other related products to national and regional customers.

Uniforms and other related products are also sold to local customers, including products sold to Rental customers through our Direct Sale catalog.

Uniform Direct Sales revenue accounted for 11% of Company revenue in the second quarter.

Second-quarter revenue of $111.9 million represents an increase of 2.9% compared to last year's second quarter.

Organic growth was also 2.9%.

The revenue from this segment tends to be a bit choppy based on the timing of new product rollouts, refresh programs, and customer openings.

Uniform Direct Sales gross margin was 29.6% for the quarter which is down from last year's second-quarter gross margin of 29.9%.

The decrease is mainly due to the expected cotton impact.

The gross margin of 29.6% was an improvement over the first-quarter gross margin of 28.6%, mainly due to higher volumes in the second quarter.

Our First Aid, Safety and Fire Protection Services operating segment includes revenue from the sale and servicing of first aid products, safety products and training and fire protection products.

First Aid Safety and Fire Protection revenue accounted for 10% of Company revenue in the second quarter.

Momentum continued in this operating segment as we had another good quarter.

Revenues were $101.7 million, an increase of 9% versus last year's second quarter, and organic growth was 7.8%.

This segment's gross margin was 43.1% in the second quarter compared to 41.1% in last year's second quarter.

Energy related expenses were 20 basis points higher this year compared to last year.

Improved capacity utilization from the higher volumes in both our facilities and on routes continued to drive the gross margin expansion.

The second-quarter's gross margin of 43.1% was roughly consistent with the first-quarter gross margin of 43.2%.

Our Document Management Services operating segment includes document destruction, storage, and imaging services, and it accounted for 8% of second-quarter total Company revenue.

Document Management revenue increased 7.9% over last years second quarter with organic growth of 4.6%.

As we mentioned in the press release, our second-quarter Document Management business was adversely affected by two things.

First, there was a steep decrease in recycled paper prices.

After experiencing a fairly long stretch of prices in excess of $200 per ton, the prices quickly dropped to $150 per ton during the quarter.

Although the average paper price for the quarter was relatively consistent with last year's second quarter, it was 16% below the first-quarter average.

As a result, growth of Document Management revenue and operating income slowed when comparing sequentially.

While it is difficult to predict this price for the second half of our fiscal year, our updated guidance assumes the prices will stay at $150 per ton.

The second item that adversely affected our Document Management results was the difficult economic environment in Europe.

We experienced weakness in all locations of our European business.

As a result we turn the focus of our European business to right sizing the organizations and improving operating margins.

This resulted in added costs this quarter but should provide benefit moving forward.

Our European business' revenue run rate continues to be about $40 million annually and in this quarter we operated at a loss.

To give more perspective on the North American Document Management business, its organic growth for the second quarter was 7%.

Its operating margin was 9.9% which was a 70 basis point improvement over last year's second quarter.

The North American operating margin is lower than the first-quarter operating margin due to the drop in recycled paper prices.

Moving to selling and administrative expenses.

We were very pleased to see second-quarter consolidated selling and administrative expenses decrease to 29.2% of revenue.

This is a decrease of 160 basis points from last year's second quarter of 30.8%.

Selling expenses continued to be lower as a percent of total revenue due to higher revenue levels and continued productivity improvements.

Administrative expenses as a percent of total revenue also decreased due to ongoing cost control initiatives.

Our efforts of controlling costs have allowed us to increase revenue by 8.8% while only increasing SG&A by 3.1%.

Our effective tax rate was 35.5% for the quarter compared to 38.3% last year.

This year's second quarter rate was positively impacted by the resolution of several tax audits.

The effective rate can fluctuate from quarter-to-quarter based on tax reserve builds and releases relating to specific discrete items.

As noted in our press release, we expect the effective tax rate for the entire 2012 fiscal year to be 37%.

Turning now to the balance sheet.

Our cash and marketable securities were $338 million at November 30, up $61 million from the $277 million at August 31.

While our Board of Directors approved a new $500 million share buyback authorization in October, we did not make any purchases under the program during the second quarter.

Keep in mind that in early December, we made our annual dividend payment of $71 million and a semiannual bond interest payment of $25 million.

Accounts receivable increased by $8 million since August 31, primarily because of the higher revenue levels.

DSOs on accounts receivable was 40 which is the same as of August 31.

New goods inventory at November 30 was $288 million, up $8 million from August 31.

This increase is mainly due to continued high demand levels in our Carhartt program, our flame resistant clothing line, healthcare items, and some build for winter seasonal wear.

We continue to expect to see inventory levels decrease during the remainder of fiscal 2012.

Accrued liabilities increased $94 million compared to August 31, primarily due to the $71 million accrual of the annual dividend and accrual of bond interest payments.

Long-term debt at November 30 was $1.3 billion of which $226 million was in current liabilities.

We have $225 million maturing on June 1 of 2012.

We intend to pay off this amount with a combination of cash on hand and short-term borrowings under our commercial paper program; however if longer-term borrowing rates remain at the attractive low levels they are currently, we may re-evaluate and decide to refinance the amount.

The average rate on the outstanding debt is 5.1%.

Total debt to EBITDA is two times.

Moving on to cash flow.

Cash provided by operating activities in the second quarter was $119.4 million which is up from last year's second-quarter amount of $73.9 million.

In addition to higher net income, the rate of growth for working capital needs came down as we expected.

CapEx for the second quarter was $35.4 million.

Our CapEx by operating segment was as follows.

$21 million in Rental, less than $1 million in Uniform Direct Sales, $4.3 million in First Aid Safety and Fire Protection, and $9.5 million in Document Management.

We continue to expect CapEx for Fiscal 2012 to be in the range of $180 million to $200 million.

That concludes our prepared remarks and we will now take any of your questions.

(Operator Instructions) Vishnu Lekraj, Morningstar.

Congratulations on a good quarter.

Question here on your margin and your margin expansion.

Looks like it expanded pretty good over the second quarter here.

How should we think about this moving past 2012 into 2013 and is this mainly because of cost restructuring or is this partly because of pricing increases or a combination of the both?

Thanks.

It's a combination of both, Vishnu, as well as just the additional revenue that we're obtaining so we're getting the revenue growth and obviously, we're not having to add as much capacity and so I would say based on our expectations, we continue to expect margin improvement going forward.

We've been saying that for some time and I think as you've seen this year, we've been able to accomplish that and so therefore, I continue to expect margin expansion going forward, assuming kind of the economic environment that we're currently in and the rate of energy costs and other large costs that we're seeing at this time.

Has there been a significant change in terms of the mix of customers in your current or in your core Business?

Not really.

Our core Business continues to be spread among businesses of all types.

As we've talked about the last quarter or so, many of our new customers are coming from companies who had never used the programs before and that continues but it really crosses the traditional type of customers that we've always had.

A lot of service sector type customers and we have a small amount of manufacturing but it really pretty much is standardized to what we've seen in the past.

Right, one more question here on your Document Management business.

How much would you say the headwinds there this quarter were related to the European worries?

And how much was that attributable towards maybe lower prices for recycled paper?

Vishnu, more of the impact in the second quarter, especially when compared to last year is due to our European business.

The paper prices fell quite dramatically during the quarter but it primarily was towards the end of the quarter, the recycled paper price impact going forward will be larger than what we saw this quarter and that is considered in our guidance.

Got you, appreciate the time.

Happy Holidays.

John Healy, Northcoast Research.

Congratulations on a great quarter guys.

Wanted to ask a little bit about the organic growth in the Rental business.

Continued to be quite impressive and I know you don't drill down to the components but if you could talk qualitatively in terms of maybe where the source's upside may be relative to what you'd expect in this type of economy or may be coming from, any color you could give in terms of the bright spots in terms of a component of organic growth would be appreciated.

Well, John, the bright spots are some of the things we've talked about, the Carhartt program has been very successful, the fire resistant clothing line has been very successful, and a lot of our new Facility Services programs have been very successful, our tile and carpet, our chemicals are growing well.

And so we've had some real good experience there and I think the positive is that we've done this in a period of time where there hasn't been a lot of customer hiring and so if we can see some pick up in the hiring from our customers, we should see even more improvement.

Helpful, and then when I think about the SG&A level in the Business, I think this is the fourth quarter where you've seen revenues significantly outpass SG&A growth.

As we start to cycle against that building of leverage, what sort of relationship should we expect in terms of SG&A growth relative to revenue?

And are we now at the point in terms of your investments into your emerging business lines where revenue should continue to outpace that and how should we think about those two?

Well, we still have in the emerging businesses lines, we still have a lot of investment being made in the sales end and as well as establishing appropriate levels of management in markets that don't have a lot of revenue yet because we know we're going to grow into them so that's going to continue for a while.

I would say that we have done an excellent job with controlling our costs in the overhead areas.

All of the Management and the Company have put a lot of effort into making sure that we don't add headcount unless absolutely necessary.

We continue to see excellent productivity on the part of our salesforce.

I think a lot of that is attributable to the tenure as well as the vast amount of products that we're offering and the quality of the products that we're offering.

So I'd say we are, the Company continues to be committed toward letting SG&A increase at a slower rate than revenue to the extent we can and I expect that to continue for the foreseeable future.

Helpful, and then lastly, Bill, I think I ask this question every quarter but any thoughts on the M&A environment, buyer/seller expectations, are they more in line with what your appetite is as we start the new year?

Well, I think as you can see, we really didn't do any appreciable acquisitions during the quarter, nor have we done any for the year.

I am not sensing there is a lot of activity out there.

There's chatter and discussions but nothing really seems to be happening on that front and yet as you see we're continuing to grow very nicely, so we don't really need to make the acquisitions but if they become available, we will certainly look at them and do so at the appropriate values and to enhance our shareholder value for our shareholders.

But right now there doesn't seem to be a lot going on.

Great.

Thanks guys.

Andrew Steinerman, JPMorgan.

My question is about add/stops.

Could you make a comment sequentially year-over-year and also remind us how Cintas calculates its add/stops.

I think we include kind of additional services to the same customer like cross-selling a mat to a Uniform customer as an add and if that's the formula I want to know directionally how the core Uniform business was doing without cross-sales.

Well the add/stops as we I think said last quarter continued to be slightly positive.

The second quarter they were a little bit more positive than the first quarter but not appreciably so yet.

There are some pockets of adds of Uniform wearers but by and large, the majority of the adds are coming from additional products and services into our existing customers.

Sure, that's good and when you say a little more positive, you mean it's up year-over-year in the second quarter, up a little bit more than it was year-over-year in the first quarter right?

Correct.

Okay, I appreciate it, thank you.

Gary Bisbee, Barclays Capital.

I guess let me follow-up on a couple of questions that have already been asked.

On that last one, I know you've talked over the last year or so about having built out a broader customer base in the core Uniform business than you've had historically and you've talked about hospitality being one area that's grown.

How do we contrast somewhat better jobs momentum overall in the US with just not seeing any growth of Uniform wearers at existing customers?

Does that point that this is still goods producing and manufacturing heavy given that we have not seen job growth there or is there some other reason?

Are customers not adding more and having people more employees but not wearing uniforms or why are we not seeing that?

Do you have a view?

Well I think the view is, is if you look at the where the add/stop -- the employment growth is coming from, a lot of it is healthcare, and there's really, we're not doing a lot in healthcare yet.

Some of it's in the hospitality arena which is more kind of a Direct Sale program but it's like a lot of it is focused on fast food.

We don't do a lot of fast food, so I think what you have to do, Gary is you really have to look at where the job growth is at and I think you're going to find that there wasn't a lot that impacts our area.

Our traditional customers.

Now we do not have a lot of manufacturing type customers.

It's less than 15%.

Most of our customers are more in the service arena, but we're not seeing a lot of job growth there.

Okay, and then following up on the question of SG&A that continues to be a really good story.

You're comping what had been double-digit SG&A growth for a year, I guess with this quarter and now it would appear to be more difficult comps just in terms of the growth rate of spend has slowed a lot.

Can you continue to generate this type of revenue growth with a much more modest SG&A investment or should we think that because you've now lapped that in the comps would appear to be a little more difficult that the actual year-to-year growth in that spend might accelerate a little bit?

Well, it's difficult to say.

Obviously we are up against a little bit more difficult comps but I think we believe we will be able to continue to grow and while maybe the rate of SG&A improvement won't be as great, we continued to expect or to be improved SG&A leverage as we go forward.

Okay, and then I just wanted to drill down a little bit in the First Aid, Fire Safety business.

The margin gains there have been terrific over I guess a year and a half or so now and you mentioned both capacity utilization both at facilities and in the routes.

Can you give a little more color on both of those?

I guess I'm trying to understand where the facility is.

Is that just driving more sales out of a distribution center for one of these or is there some other part of the facility where there's a real opportunity to get that kind of increased capacity utilization?

And on the routes, is that just selling more customers or is it also more products on the truck?

Thanks.

Gary, in our facilities for example, our First Aid facilities generally they are a warehouse with inventory and we've got very very much capacity so in other words, there certainly is a specific investment in the warehouse but as we continue to grow we'll get more and more sales on top of that warehouse as well as turn the inventory more.

From a Fire perspective, Fire Protection perspective, in our production facilities, we recharge portable fire extinguishers and do some other work so that as we continue to add revenue in the Fire side, we will continue to get leverage from those facilities.

From a route standpoint, going back again to First Aid, we are adding more revenue to every customer because we are expanding product lines, we're adding training services, and as jobs get added, it results in more hands in the cabinet, so our routes are certainly becoming more efficient by more sales at each customer.

We're also selling new business and adding customers but we're also expanding each customer.

And from a Fire standpoint, we're doing a lot of the same things.

We're expanding our services and making each customer more valuable.

And so you've made good progress there certainly in the gross margin.

Is there a point where that gets more difficult to come by?

It seems like you should still have on the pretax margin some room as you scale the business or is this a business that could well have gross margins nicely above the Uniform over time?

I think it can have gross margins equal to the Uniform business over time.

I think we still have a lot of operations around the country that have not gotten to the stage where they're producing those margins because they are just not large enough so we've got that ability going forward, so there certainly is room for improvement going over the course of the next few years.

Okay, thanks a lot and Happy Holidays guys.

Andrew Wittmann, Robert W Baird.

Mike, I just want to dig in a little bit more into the Uniform segment numbers a little bit more and try to really just understand, can you break out the growth rates that you saw maybe in the quarter for core Uniform, maybe versus the hygiene and some of the other things?

Can you just give us a sense as to what was kind of maybe really driving that segment versus maybe what was holding back a little bit?

Andy we don't get into that level of detail.

We will typically give the break out in our fourth quarter but we don't typically get into that level of detail but I'll tell you, we had nice growth and improved growth rate in all of our business lines in the garments, garment rental, in the Facility Services, so it was a broad improvement during the quarter.

Okay.

Just as it relates to the chemicals, we're probably a quarter or so now into the new product line that you're sewing there.

Has that been, is it fair to say that that's been one of the drivers of the hygiene segment?

It's still a really small element of the overall revenue growth.

I mean of the overall revenue, Andy.

It is, it did grow nicely in the quarter, met our expectations, but it is relatively small so it doesn't have that big an impact yet.

Okay, great and then just on the guidance, I just want to understand what's really implied here.

Is the view for the rest of the year improved because you're feeling better about the second half of your fiscal year or is this just passing through out-performance from what's already occurred?

I just kind of want to understand how you're looking at it from here and is it fair to assume that given the reduction in paper prices that guidance all else equal would have been higher if you didn't have this reduction in paper prices?

We have adjusted the guidance based on both the performance year-to-date where we have significantly beat expectations as well as we look to the rest of the year, we feel more comfortable as Mike said of being able to perform even in this lackluster economic environment and you're right.

Had it not been for the paper price drop, we would have been able to report or to provide guidance that was even better than this, so we still continue to believe that we're going to be in a very sluggish economy and we've taken into account this very dramatic drop in paper prices into those numbers and yet I think we are signaling a pretty nice improvement this year over the prior year based on our results to date and our expectations.

Yes, I'd say.

And then on the buyback, clearly you had a partial quarter where potentially you could have been buying, you elected not to or perhaps you were blacked out.

With the M&A market not being overly conducive today, can you just talk about was there something going on there that maybe prevented you from going in the market or was that really just a decision at this point?

Well I think we have to manage our cash flow.

We have obviously just received that authorization in late October.

As Mike said we paid our dividend in early December and we paid a lot of interest and we continue to stay in close touch with the Board and look at the market situation and we will report each quarter what we decide to do on that authorization.

Okay.

I'll leave it there, thank you.

Scott Schneeberger, Oppenheimer.

Going across all the segments but starting with Rental, Bill, I think you made a comment that you're seeing less aggressiveness in pricing.

Could you just address that in Rental and talk across the segments?

Thanks.

Mike said that in his comments, we saw this last quarter where our competitors finally face the music with the rising commodity costs that they were seeing and they became more rational in pricing and while we had continued to be very disciplined on our pricing with the competitive environment improving which continued into this quarter we saw a little bit more pricing power.

So that, pricing has not returned to where it was but it certainly has become more of a possibility of getting better pricing than what we were seeing a year or so ago.

And I would say that's most pronounced in the Rental business and especially in the garment business because that was who our garment competitors were who were really driving prices down for a while.

In our Document Management business, as we've seen high paper prices for the last year or so, we've seen some pressure on the service side of the pricing and while the paper prices came down dramatically towards the end of the quarter, it may take a little bit of time to get those service prices back up but we certainly have seen aggressive pricing in that business.

Logical.

On the pricing thing, I'm curious, I'm looking at a chart of cotton, and after that huge spike throughout the past fiscal year, it looks like it was almost fairly flattish in this quarter.

It was obviously a big issue for your Company last year.

Have you made any significant changes?

I heard you mention the performance with regard to that was in line with the quarter for your expectations.

Did you make any big changes, how did you treat pricing and any change into the makeup of your uniform synthetic versus cotton?

Thanks.

There's been really no changes of any significance in our uniforms with the mix.

We're continuing to work with various fabric suppliers and looking at alternatives but nothing has really entered the chain yet.

Keep in mind that the cotton prices while they have come down this year are still above historical levels, and while they are significantly below where they are last fall, all of that cotton that came in to the supply chain last fall really didn't get into the garment and the distribution centers until the spring and now are really starting to be injected into the Rental programs both for our competitors as well as ourselves and as we've said you have those high cotton prices remain with you for a while because of the amortization and the period of time it takes from the cotton at the farm until it gets into the garment.

The lower prices, if they are sustained, will certainly help lessen the impact of cotton into the future, but we are kind of stuck with those higher prices at least through this fiscal year and into part of fiscal '13 and then as I said even the prices today are still above historical levels, so they don't seem to be coming down as quickly as they did from the fall to the first of the summer.

Got it.

Thanks, two more quick ones and I'll ask them both at the same time.

Just heard some questions about how you're thinking about M&A.

You had done some in Document Management in Europe and Europe does not look too healthy.

Just curious, are you still committed there or are you maybe going to back off that for a while?

And then the second question is with regard to not being active with share repurchases and I heard your very valid answer for that but if you are considering a refinancing, is there any thoughts to hold a large cash balance in front of that to look attractive to the banks?

Just curious how that works, thanks.

The European, I think I mentioned this the last couple quarters.

We had pretty much decided to focus on the acquisitions we had made in Europe and then to determine how well we could grow those businesses, what we could do with improving the profitability and so the strategy that we had was that we were really not going to be very aggressive for a period of time in Europe.

We were going to work with what we have and that is what we are doing.

We have not lost interest in Europe.

We still think it's a very good market for the Document Management business.

They have obviously had their economic issues over there and we are taking appropriate action on those businesses to make sure that they will regain profitability and then we can position ourselves for growth.

Regarding your question on maintaining a cash balance I don't think that would have anything to do with that for what it would look like for purposes of appealing to a bank or to the financings.

Most of our financing would be public financings anyway.

I think the whole use of cash whether we use it for share purchases, whether we use it for M&A, whether we do pay off of our debt is all going to be taken into consideration based on the environment, looking at what happens with our share price, what happens with our Business, and we'll continue to assess that month-by-month as the conditions warrant.

So I would not make a big deal why we didn't execute anything under that authorization because of the short timeframe we've had since then but we will continue to monitor that and given our guidance, we're going to continue to generate a lot of nice cash flow.

Understood, thanks guys.

James Samford, Citigroup.

Obviously you're at record revenues here.

How much more capacity utilization is there available to you and where are you relative to certain prior key peaks in terms of utilization of your facilities?

Well, James, the good news is our guidance gets us higher than our previous high in revenue but we've used a lot less capacity in getting there and by that I mean we've grown our Facility Services business which includes our hygiene business, tile and carpet, some chemical business that don't use production capacity in our Rental facilities and so we've still got a fair amount of capacity generally speaking.

Now capacity is a local thing and there may be pockets where we are closer to capacity levels but generally speaking we've got a lot of capacity in our infrastructure and as we continue to grow especially in non-processed revenue, we should continue to get more leverage.

And what is the mix at this point of Uniform versus non-Uniform related product or revenue?

Well it was about 50/50 in our Rental segment as of our fourth quarter last year.

Right, I assume that hasn't changed much in the last couple quarters then?

Not appreciably.

We'll update that at the end of the year but not appreciably, James.

Sorry if I missed it but did you provide any cash flow expectations for the year?

No.

We don't really provide cash flow expectations.

Okay.

That's it for me, thanks.

Sara Gubins, Banc of America Merrill Lynch.

Are there particular industries where you're seeing strengths or weakness in the Uniform Rental business?

I'd say FRC, the flame resistant garments continue to be one of the stars and that's primarily in oils, the energy fields, energy processing, chemical processing, et cetera.

That continues to be very strong.

Healthcare is picking up some momentum as we look at opportunities to provide a Rental product in the healthcare industry and then we are starting to make some head way in Rental programs in the hospitality sector but those are relatively small at this point.

Okay, and then any areas of particular weakness?

No, I don't think so.

We're not seeing that.

Okay.

Could you give us an update on how new sales trended this quarter?

New sales was generally very good.

It improved from our first quarter, so sequentially we saw a little bit better results.

Our productivity still remains very good and we're very pleased with that.

Great, thank you and then just last question, more conceptual but how much visibility do you get from your clients if they're thinking about adding new programs?

Very little, Sara.

Our clients don't really tell us what they're going to do.

We continue to have our salespeople and our service people trying to penetrate them with additional products and services but we don't get a lot of visibility from them as what their plans are.

Okay, thanks a lot.

Nate Brochmann, William Blair.

Great quarter.

Wanted to talk a little bit, I mean we talked a lot about some of the newer services, but clearly they're seeing a lot more momentum and I applaud you for the efforts you put in over the years to build that.

Strategically, how do you think about the balance of investment in some of the newer developing services versus some of the traditional ones?

And where do you feel you are in terms of scaling those businesses and the opportunity for continued growth?

Well, as Mike said, let's take the different businesses, the Rental business, while we'll have to continue to invest in the capacity on the route side from the production side, we don't have the need for a lot of additional investment other than for replacement and improvement type capital, so we're not anticipating having to build a lot of Rental facilities in the near future because of the available capacity and the different mix of the business.

But on the emerging business side, we will continue to invest in the expansion capital for additional trucks, additional facilities as we fill out the footprint across the country and we're continuing to be very excited about the opportunities there.

And Bill, just along that, could you talk about your customer base in some of those developing services, whether it's really for the moment penetrating current customers or existing customers with other services or are these completely kind of new customers in these new categories that then creates even a broader opportunity to eventually cross sell?

Well, it really is quite complicated.

If you take each business, for example, all of our Uniform Rental customers and all of our Facility Services customers are candidates for some of our other products and services.

Now, a two or three-person auto repair shop is not a good candidate for Document Management nor are they a good candidate probably for the First Aid and Safety business but we have a lot of let's take a car dealership.

A car dealership has the need for Uniform Rental, Facility Services, Document Management, First Aid and Safety, Fire Services, so it really depends on the size of the customer and the specific business they're in.

Now if you go to the emerging businesses, Document Management has primarily been used in financial institution and healthcare facilities.

They are outstanding candidates for a lot of our Facility Services business and our First Aid and Safety and Fire Services business, so we would look at every customer that we have in each of the different businesses and the sales teams work together to determine are they good candidates for some of the other products and services and if so, then we begin to work on selling those products and services into that customer.

And then in terms of your current customer base, buying more than one service, I would assume that's kind of still in its infancy?

It's in a little bit more than in its infancy but there's a lot of opportunity yet to be had.

Great.

Thank you very much.

Greg Halter, Great Lakes Review.

On the M&A side looks like there's about $8 million in the quarter.

Can you provide any indication on what specific segments those may have occurred in?

They really were primarily in there was some Fire or I'm sorry, there was some Document Management and some Rental Facility Services acquisitions there.

Nothing significant.

And one last one for you, regarding the program or non-programmers I guess related to new business.

What kind of metrics can you share there?

Our second-quarter experience was roughly the same as the first quarter which was an improvement over what we saw during the downturn where we did not see quite as many no programmers but we're back to levels that we had seen pre-recession and feeling very good about that and it is lead certainly by some of our newer products and services like the Carhartt program and FRC.

Okay, great.

Thank you.

Joe Box, Keybanc Capital Markets.

Bill, I have a follow-up on your prior point that you'll probably have to make some route based investments before plant level investments.

Can you just talk about maybe where you're at on a capacity standpoint for trucks and drivers among your different businesses?

I really can't, Joe.

Obviously I have thousands and thousands of routes out there.

I can tell you that generally speaking, when we hit the recession, our Management teams did a lot to right-size the routes and do rerouting, to keep the capacity relatively full there.

So as we see volume coming back especially as it relates to new customers, we tend to need to add back that capacity by putting a truck back into service by putting the driver back into service.

Now, if the volume comes back from an existing customer, normally that can be handled on the route that that customer is currently being serviced, so really it depends on the mix that's happening with where the revenue is coming from.

That's helpful, thanks, and my follow-up question for you is on incremental margins.

I guess with comparison getting much more difficult in Q3, how should we think about incremental operating margins over the next few quarters?

We're still comfortable that we'll continue to be able to expand operating margins.

At the degree of that expansion depends on where the business comes from.

Obviously, increased volume at existing customers is more profitable than new customers in the short-term.

It also will depend on what happens with the level of cost and we're making the assumption that generally there will be no significant change in our cost structure like in energy and medical and that sort of thing over the next several quarters with given that then we expect there to be margin expansion.

Thank you.

Thomas Allen, Morgan Stanley.

I know you don't try to hold yourselves out as economists but just trying to gauge how optimistic versus cautious your guidance is taking into account recent trends.

I don't think many people believe that 8.6% on unemployment will flatline going forward.

I know our economists believe GDP is growing above 3% quarter-to-date and so expect 2% GDP growth going forward, so basically we're in a very choppy macroenvironment.

Just trying to understand is your guidance to factor in recent as in like the past few months trends or slightly longer-term trends?

I think it's taking into account kind of what we have seen over the last few quarters.

We don't really base our view on what the GDP growth is because that doesn't necessarily drive our growth, but I would say we continue to look at the future cautiously but I feel obviously better now than I did a year ago but it's still a tough environment.

And if we could see some real job growth in the economy, you would see some very nice growth with our Company's revenues, significantly even more than what we have so far, so we've been able to perform in this economy and as I said I don't think we really foresee it changing much over the next several quarters.

Okay, thanks, that's all I had.

Gary Bisbee, Barclays.

I wondered if you could give us a sense what the year-to-year hit to the gross margin in Rentals was from the cotton prices and if you don't want to give that number, can you just give a sense as to how that should change in the back half of the year?

So you'd given us previously the less than $15 million in dollar terms growth in the cost.

Does that get much worse in the next two quarter relative to what it just was?

Thank you very much.

Gary I think it's a ratable increase from the first quarter through the fourth quarter, so if you think about that $15 million or so, it is a relatively minor amount in Q1 growing with each quarter and then as you may have heard the last couple calls, we've said it will continue to grow to the tune of an extra $5 million next fiscal year, so it wasn't significant in the first quarter.

It's growing a little bit.

It will grow a little bit more but we still expect it to be in the $15 million or lower range.

For the total year.

For the year.

Okay, so it's a modest headwind to gross margin sequentially in the back half of the year?

Right.

Yes.

Okay, thank you very much.

And we have no further questions from the phone audience.

I'll turn the conference back to our speakers for any additional or closing comments.

The only thing I'd like to say is thank you all for joining us this evening and best wishes to you and your families for a very Happy Holiday.

Thank you.

Ladies and gentlemen that does conclude today's conference call.

We would like to thank you all for your participation.