信達思 (CTAS) 2013 Q1 法說會逐字稿

Good afternoon, everyone and welcome to the Cintas quarterly earnings results conference call.

Today's presentation 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.

Thank you for joining us this evening as we report our first-quarter results for fiscal 2013.

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

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

The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor from civil litigation for forward-looking statements.

This conference call contains forward-looking statements that reflect the Company's current views as to future events and financial performance.

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

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

We are pleased to report first-quarter revenue of $1.051 billion, which represents growth of 3.4% from last year's first quarter.

First-quarter net income increased by 11.8% to $77 million, and earnings per diluted share were $0.60, a 15.4% increase over last year.

Our operating margin for the first quarter improved to 13.2% from last year's first quarter operating margin of 12.6%.

Energy-related costs were 40 basis points lower in last year's first quarter.

However, this positive impact from energy was more than offset by the $8.3 million negative impact of lower recycled paper prices this year.

Keep in mind that in addition to negatively impacting revenue, lower recycled paper prices directly impact operating income as well.

Aside from these two items, the improvement in operating margin was mainly due to continued efforts to manage our cost structure.

When we announced our fiscal 2013 guidance in July, we commented that the absence of momentum in the US economy, as well as numerous sub 2% GDP forecasts for the remainder of 2012 and 2013, caused us to view fiscal 2013 with caution.

Our assessment of the economic climate has not changed since then.

The disappointing employment picture has continued and various reported economic data during the past two months have not been encouraging.

However, despite this negative climate, we continue to be pleased with the performance of our businesses.

And as a result, we reiterate our fiscal 2013 revenue expectations to be in the range of $4.25 billion to $4.35 billion.

We are updating our fiscal 2013 earnings per diluted share guidance for the impact of our first-quarter share buyback.

While the 1.8 million share buyback had no impact on the first quarter results, it will benefit the remainder of the year by $0.03.

As a result, we now expect earnings per diluted share to be in the range of $2.50 to $2.58.

Let me make a few comments about this guidance.

The guidance assumes no further deterioration in the US economy.

Mike generally comments on the workdays by quarter.

The number of workdays does affect revenue and operating income levels.

Keep in mind that our second-quarter workdays are 65, one less than the first quarter, but the same as last year's second quarter.

The third quarter, however, has only 64 workdays, 2 less than this first quarter and 1 less than last year's third quarter.

This third quarter workday impact, coupled with the uncertainty surrounding a fiscal cliff impact, may result in a difficult year-over-year comparison for the third quarter.

While the first quarter recycled paper prices were significantly lower than last year, those prices were generally in line with our expectations.

Our expectations for the remainder of the year have not changed since July, roughly $170 per ton in the second quarter, followed by a $10 increase in the third and fourth quarters.

And finally, as I mentioned, the guidance incorporates the share buyback from our first quarter but does not contemplate any additional buybacks.

Now I would like to turn the call over to Mike Hansen for more details on the first quarter.

Thank you, Bill.

As Bill mentioned, total revenue increased 3.4% from the first quarter of last year, with total company organic growth being 3.2%.

Total company gross margin for the first quarter was 42.4%, which is down from last year's first quarter gross margin of 43.2%, due to lower recycled paper prices and higher material costs.

I will discuss these items in more detail by segment.

Before doing so, let me remind you again that there were 66 workdays in our first quarter, which is the same as last year.

Looking to the remainder of fiscal 2013, our workdays will be as follows -- 65 in the second quarter, 64 in the third quarter, and 66 in the fourth quarter.

The workdays in the second and fourth quarters are the same as last year.

The third quarter has one less workday, as Bill mentioned, than last fiscal year where there were 65 workdays in the third quarter of fiscal 2012.

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, mats, towels, and other related items.

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

Rental Uniforms and Ancillary Products revenue accounted for 72% of company revenue in the first quarter.

First-quarter rental revenue was $754.8 million, which is up 4.9% compared to last year's first quarter.

Organic growth was also 4.9%.

We are pleased with our revenue performance for the quarter, despite the sluggish economic environment.

Our sales reps continue to perform at relatively high productivity levels, and our lost business improved from last year's first quarter.

During our July earnings release call to report fourth-quarter results, we indicated that our net add stops trend worsened in that fourth quarter.

That trend did not continue to worsen through the first quarter.

Historically, we have experienced a seasonal pickup in net add stops from the fourth quarter to the first quarter and we did in fact see that normal pick up during the quarter.

Our Rental segment gross margin was 43.3% for the first quarter, a 60 basis point decrease from last year's first quarter gross margin of 43.9%.

Energy-related costs were down 50 basis points compared to last year's first quarter.

This benefit, though, was primarily offset by an increase in material costs due to the high level of new business from the past several quarters and the expected greater cotton impact.

High levels of new business require incremental injection of new inventory.

The first quarter gross margin of 43.3% was consistent with the fourth quarter of last year.

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 10% of company revenue in the first quarter.

First-quarter revenue of $100.3 million represents a decrease of 1.4% compared to last year's first quarter.

We have seen some softening in our rental catalog business, which is consistent with the general cautiousness of our customers.

But this revenue level was consistent with our internal plan.

We are currently gearing up for several large rollouts scheduled for the second half of the fiscal year and expect this operating segment to have a good year.

Uniform Direct Sales gross margin was 29.4% for the first quarter, which is up 80 basis points from last year's first quarter gross margin of 28.6%.

This segment's gross margin can move from quarter to quarter due to changes in mix of product, and timing of program rollouts.

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 first quarter.

Revenue was $110.8 million, which is record quarterly revenue level for this operating segment.

It was an increase of 6.8% versus last year's first quarter revenue, with organic growth being 6.6%.

We are pleased with the performance of both the first aid and safety business, and the fire protection business.

This segments gross margin was 43.1% in the first quarter, which is about the same as last year's first quarter of 43.2%.

Improvements in warehouse capacity utilization and lower energy related costs were offset by expanded route capacity due to this operating segment's growth over the past year.

The first quarter gross margin of 43.1% was an improvement over the 42.4% in last year's fourth quarter.

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

Document management revenue decreased 7.5% compared to last year's first quarter.

Revenue decreased organically by 8.3% compared to last year.

Year-over-year Document Management results continue to be negatively affected by lower recycled paper prices and difficult operating conditions in Europe, including a weaker euro.

The average recycled paper price during the first quarter was roughly $170 per ton, which was an improvement from last year's fourth quarter average of roughly $150 per ton.

However, the first quarter average of $170 per ton was a significant drop from last year's first quarter average of $275 per ton.

This lower year-over-year price negatively impacted revenue for the first quarter by $8.3 million.

And this impact also directly affects the gross margin and operating margin of the business.

Europe continues to be a challenging operating environment.

Revenue growth has been difficult and the weaker euro, relative to last year's first quarter level, negatively impacted the results.

Switching to selling and administrative expenses, SG&A was 29.2% as a percentage of revenue in the first quarter.

This is an improvement from last year's first quarter of 30.5%.

This 130 basis point improvement from last year is due largely to improved workers comp claims experience and lower amortization of deferred charges related to prior year acquisitions.

First quarter selling and administrative expenses of 29.2% of revenue were higher than the 28.8% in last year's fourth quarter, in part due to normal first-quarter expenses as we begin our fiscal year.

Our effective tax rate was 37.5% for the quarter, compared to 38.5% last year.

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

For the full fiscal 2013 year, we expect our effective tax rate to be 37.3%, which is slightly higher than last year's 36.8%.

Last year's rate was impacted favorably by the resolution of federal audits.

Turning now to the balance sheet, our cash and marketable securities were $330 million at August 31, down $10 million from the $340 million in cash at May 31, primarily due to the share buyback of $71 million during the first quarter, offset by cash generated from operations.

Included in the $330 million at August 31 was $49 million of cash located outside of the US.

Accounts receivable increased by $8 million since May 31.

DSOs on accounts receivable were 40, which is the same as at May 31.

New goods inventory at August 31 was $242 million, down $9 million from May 31.

Inventory continued to normalize during the quarter, from higher post SAP conversion levels.

We are now seeing some efficiency gains from SAP.

We do expect an increase in the remainder of the year due to the large rollouts in uniform direct sales mentioned earlier.

Accrued liabilities decreased $43 million compared to May 31, primarily due to lower accrued bond interest and accrued profit-sharing.

Long-term debt at August 31 was $1.3 billion.

We had $225 million of 6% 10-year debt mature on June 1, and we refinanced that with a new issue of $250 million 10-year debt on June 5 with a coupon of 3.25%.

As of August 31 our total debt-to-EBITDA remains slightly below two times.

Moving on to cash flow, cash provided by operating activities in the first quarter was $95 million, which is up from last year's first quarter amount of $57 million.

In addition to higher net income, the decrease in inventory during this year's first quarter and an increase in accounts payable added to the improvement over last year.

CapEx for the first quarter was $47.4 million.

Our CapEx by operating segment was as follows -- $32.1 million in Rental, $2.4 million in Uniform Direct Sales, $3.9 million in First Aid, Safety and Fire Protection, and $9 million in Document Management.

We expect CapEx for fiscal 2013 to be in the range of $190 million to $210 million.

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

Thank you.

(Operator Instructions)

Sara Gubins, Bank of America.

In your prepared remarks, you mentioned that add stops, that the trend had gotten better.

Last quarter, you had mentioned that they had both worsened but also turned negative.

Could you talk about what you saw in the first quarter?

Was it still negative?

Or did it turn back positive?

We generally see, Sara, a positive movement in the first quarter from the fourth quarter.

A seasonal impact.

And it did in fact turn positive.

Okay.

Great.

And then I think you had talked about expectations of SG&A being flat as a percent of revenue for the full year.

Is that still what you're expecting?

I think we would expect a slight improvement in SG&A for the year, Sara.

Great.

Thanks a lot.

That was consistent with what we said before.

Okay.

It should be down year-over-year as a percent of revenue?

Correct.

Okay.

Thank you.

Nate Brochmann, William Blair & Company.

Want to talk a little bit -- obviously, you guys stress the economy is still pretty weak and the unemployment rate certainly hasn't gotten better and the jobless claims seesaw from week to week, but you guys are still doing really great job in terms of winning new business.

Can you talk a little bit in terms of one, what you're doing there and two, just the general kind of feedback from your customers?

As you're going out and winning that new business in terms of why they're investing now in the face of an uncertain economy?

Nate, I think the reason that the new business efforts continue to show decent results is a combination of a couple things.

First off, it's the value of the program itself.

We've talked a lot about that.

The fact that you can get five changes each week of uniforms.

No investment by the Company or the employee in the uniforms.

Get them all taken care of for a relatively modest price is a phenomenal value.

And I think that more and more companies continue to see that.

And that's why our business results -- new business results primarily -- the majority of it is the no programmer segment.

I think the second reason is some of the product offerings that we have.

We've talked a lot about our relationship with Carhartt.

We continue to see very nice results in the FRC garments, the flame resistant garment, especially in the energy sector which is a growing sector in the US economy.

And then I'd say the next thing is in the Rental business, our facility services business.

Which is over half -- which is about half of that total Rental segment.

We continue to have very nice offerings for resolving some of the problems that companies face.

And such things as the floor care solutions, which includes the tile and carpet cleaning, the hygiene solutions, the restroom supplies, and then the addition of the chemical cleaning systems that we have out there.

I think have all helped on that side of the business.

So with all that said, I think our new business results continue to be good.

Lost business continues to show some modest improvement year-over-year.

We're just not getting the adds yet from existing customers.

Maybe when the economy turns around after there's some certainty, we'll begin to really see that and see our growth accelerate.

So sounds like at least in terms of what you've been doing on the new business in the penetration with some of the new newer service offerings, it sounds like there's still pretty decent runway to go on that, then?

Yes.

I think there certainly is.

And we are continuing to invest in our sales force.

We believe we've got some compelling product offerings for customers.

And we continue to feel very bullish about it.

Just a pickup in the economy will really accelerate some of that growth rate and improve profitability, certainly.

That's great.

Thanks for all the color, Bill.

And I'll turn it over.

Shlomo Rosenbaum, Stifel Nicholas.

I want to piggyback on the last question.

You guys are certainly growing very respectively in the Rentals business, way above what the overall GDP is growing.

Is the growth coming on the Rental side more from the ancillary businesses?

Can you give us a little bit more detail on that?

Good question, Shlomo.

Mike and I looked a lot at that in preparation for this call.

And it's really comparable growth, both in uniforms and in the facilities services side.

So while it may be a little bit surprising to people, the fact that our new business efforts are successful in both sides of that Rental business I think is encouraging.

And I think what it tells us is that it's still a good value, as I was just mentioning to Nate, for a company for both the uniform, as well as the facilities services side.

So I'm encouraged by that.

Okay.

And then in terms of the growth, you said it's primarily no new programmers.

Is there a trajectory there that more and more of your business is new programmers versus takeaways from competitors?

Or is there any change in that over the last year or so?

The last year or so, it's been about almost two thirds of our new business has been no programmers.

And that was -- if you went back pre-recession, that was what we were experiencing pretty much on an ongoing basis.

Then during the recession, we saw less of that and more competitive wins.

I think our salespeople continue to find that given the fact that many of our -- that all of this business is contractual business, it's difficult to take it away from a competitor until it gets to the end of the contract.

And I think we continue to see a lot of focus in the no programmer side because that's much easier to get than waiting for a contract to expire.

Makes sense.

And then what are you seeing on the competitive side?

Are you seeing any deals where you are in competition, is it rational?

Are you seeing competitors feeling that they have to hold the line on price more?

We had seen more of that going through the last of the year, last year.

Unfortunately, I think what we're seeing right now is with the slowdown in the economy over the last several months, I'd say competitors have returned to a little bit more aggressive pricing.

Hopefully that will be a short-term situation.

We don't think that's a good way to go.

That's why we continue to focus on profitable business.

But I would say that is all dependent on how the economy -- when it picks up.

Okay.

Great.

Thank you very much.

Thomas Allen, Morgan Stanley.

Can you give us more color on how the different segments of the Document Management business did?

So the shredding, recycled paper sales volumes, storage and also imaging?

Thank you.

Thomas, we have -- we've not necessarily gotten into that level of detail, but I can tell you, I mentioned on last quarter's call that the Document Management growth without recycling was about 1%, mainly because of the issues in the European operating environment and our storage and imaging were -- which is such a project based business was down.

In the first quarter, we saw that improve to over 2%.

And while we're still seeing a good performance in our shredding business, the project based business in storage and imaging is still not strong.

And the European business is still in an environment where it's very difficult to grow.

And the weaker euro really had an impact, a negative impact on the quarter too.

Okay.

Thanks.

And just a numbers question, your D&A dropped significantly this quarter, what drove that and is this the right run rate going forward?

Thanks.

We had a decrease in our amortization due to some intangibles related to prior acquisitions that rolled off.

And so I think the run rate is a good one from going forward, anyway.

Okay.

Thanks.

John Healy, Northcoast Research.

Bill, I was hoping you could run past some of -- over again some of the comments you made on the SG&A line, the sources of it being down.

I understand that amortization point, but I don't know if I caught it all but I thought you mentioned something on workers comp and I wanted to make sure I understood it.

We had a little bit better experience in workers comp in the quarter than what we saw in the first quarter last year.

That will fluctuate, John, depending on what happens when cases get resolved, et cetera.

So there was some minor improvement in our medical expense, but generally speaking, as Mike alluded to, the -- a more significant impact would have been the drop off of the amortization of the deferred charges.

Okay.

And Bill, I was hoping maybe you could take a step back and talk philosophically in terms of how you're thinking about the business today.

When I think about your company over the last five to seven years, it's always been about building a sales organization and building a sales structure that would take you into new business lines and really propel the growth of the Company.

Then for a while it caused the SG&A line at times to grow faster than revenue, and for a number of quarters we've seen revenues grow faster than SG&A and SG&A come down.

What is the new normal for you guys?

In terms of the investments you need to make into the sales force and how should we think about sales growing relative to revenue?

Because you keep outperforming I think everybody on the SG&A line and I'm trying to understand how we should be thinking about how you should be performing there.

I think philosophically, we always believe that we need to get leverage in our G&A portion of the Company.

And given the fact that we are now growing that top line again over the last couple of years versus what we did during the recession, we're able to do that.

We also have seen some better performance on the part of -- in our workman's comp and our medical expenses, which have helped.

The union fight is, for the most part, over.

So that has certainly helped some of the legal expenses that we were incurring.

So I think we're back to where we want to be with a growing top line and leveraging that G&A.

On the sales side, we believe that we have staffed appropriately for all of our businesses in order to grow those businesses.

And I think our new business results have been very good over the last couple of years, reflecting this high productivity level we're getting from the sales force.

We continue to increase appropriately, in the correct markets, the number of salespeople we have, but I don't think we're going to need to do a significant step up in that in order to get our growth.

We feel that where we're at is appropriate.

And it will be modest growth going forward.

What we would like to see, again as Mike mentioned, is some existing customer growth when they add back employees.

And if we can get that, then we'll return to double-digit company growth that we've been talking about for years.

Great.

Thank you so much.

Andrew Wittmann, Robert W. Baird and Company.

I wanted to dig into the guidance a little bit.

My calculations suggested for the back half of the last three quarters of this fiscal year that revenue growth was in the 3.7% to about 6.9% range.

When we look at this quarter, even adding back the paper price headwind that you faced, you're looking at about 4% growth for the quarter so looks like the top end would imply some acceleration.

I just want to, Bill, to get a little perspective from you.

What are some of the variables that could suggest -- in what you're seeing today, what are some of the variables that could help you get to that high end of the guidance range?

A couple things.

First off, it will be -- we're pretty certain on the direct sale business, as Mike mentioned, that you're going to see an acceleration in that because we've got some large rollouts and that's in the plan and embedded in the guidance.

But to get to the top end of the guidance, what I would say you would see is a better economy, therefore an improvement in the confidence level on the part of business owners to either add employees or to make discretionary spends.

As we talked, our catalog business was relatively flat.

We think a lot of that is just caution on the part of the business owner.

We could see getting to the top end of that range caused by better than expected increase in paper prices than what we've embedded in there.

And I would just say, employers just willing to add an employee here or there is going to have a positive impact on that.

Now, with all that said, I want to reiterate a point that Mike made, and I tried to make is as you guys layout your guidance, keep in mind this third quarter as these fewer number of workdays and also, I think the most difficult period we may have is right around the end of the calendar year.

So our guidance anticipates that the fourth quarter should be pretty decent.

Third quarter is not going to be quite as good, just because of all these other factors that are going on.

But I'd say we have pretty good confidence in the guidance that we gave you.

And hopefully we'll be able to achieve that top end if the things that I mentioned earlier happen.

That's a helpful answer, Bill.

I want to dig also a little bit into the Rental segment's gross margin.

Maybe I missed some numbers.

Some of them I got, it sounds like for the segment energy was a 50 basis points benefit.

Mike, what was the garment -- both through cotton and new injections -- headwind that you experienced there?

I'm just trying to understand the delta on a year-over-year basis to understand what some of the pieces were.

You're correct about the 50 basis points of energy.

Material cost was a headwind, like it had been in the previous couple quarters.

We haven't gotten publicly into the details of the increase in material costs.

But that wasn't the entire piece.

There were other things here and there, none of which were significant.

Generally speaking, we saw -- I think if you look at the Rental gross margin in our first quarter, it was pretty consistent with the previous three quarters.

And I'll tell you, last year's first quarter was a pretty good quarter.

That 43.9 was a quarter we hadn't seen in the last three or in the previous couple.

And part of that was due to we started to see an acceleration in our Rental business.

We were getting a lot of leverage.

And the growth is causing us to now add some routes and to add some resources.

And so our first quarter was consistent with the previous three.

We just had a really nice quarter in the first quarter of '11.

You didn't talk really about price in that response.

I'm just trying to understand -- sounded like your commentary already said it's kind of heated up and gotten a little bit more competitive.

Is price at least some of the delta that we saw?

I'm not sure that I would say it was much of the delta, Andy.

Okay.

And just a final question, if I might, on the Document business, here in the 1% or 2% range from last couple quarters.

Last year was kind of mid-single digits.

Just wondering what was the change primarily?

Is it a volume thing?

Is it a pricing thing there?

Competition?

Retention rates?

Just some sort of color to understand a little bit what's happening in the last couple quarters versus maybe last year?

I think it's project oriented business that really impacts the imaging business.

And as we mentioned in the fourth quarter, recall one of our strategies is to get more recurring business there.

But we had a lot of -- I call one-time projects, especially in the financial institutions.

So that had an impact on it.

We're just not seeing much growth at all in storage, and therefore, that's one of the reasons we've always said that our preference is more on the shredding side.

The European business, we beat that quite a bit with the euro and with the lack of growth over there.

While it's only 1% of our overall company's revenue, it's a little bit bigger piece of the Document Management segment.

And then I would say that in the shredding side, the focus has been as selling good business, there were some aggressive companies out there in the business that we don't think are necessarily long-term committed to the business that were getting pretty aggressive in the fourth quarter last year.

And even into a little bit of the first quarter this year, but that seems to be stabilizing a bit because they're seeing the results of the lower paper prices and it's impacting their profit margins.

We've got some nice customer rollouts in place -- are going to be in place here in the next couple of quarters that are really good wins for us.

So we expect this growth rate, especially on the shredding side, to really start picking up.

And then the comparables, of course in paper, are going to become much easier as we go through the year.

Very helpful.

Thank you very much, gentlemen.

James Samford, Citigroup.

Just wanted to dig in a little bit into the no programmer trends that you've added over the last couple of years.

I was wondering if -- how are they trending relative to some of the programmers that you had prior to or during the recession that have added -- that have not been adding people?

Have you basically been adding more healthy businesses relative to what you had before so the mix is changing a little bit to the better?

I would tell you that even when we added no programmer, you typically don't see a lot of increase in their headcount.

So we get a no programmer, but just as we're seeing across the general economy, they're staying with their workforce and not adding a lot to their workforce.

That's a general statement.

There's been a little pickup, as I mentioned, in the energy segment in the US, so we picked up some more of that business.

But even -- the new no programmer customers we get are not really growing their companies any more than the programmers are.

Okay.

Fair enough.

The one thing that I would add is in those no programmer accounts, when we're talking about energy-related, it's generally fire resistant clothing.

And we sold our Carhartt business, and that generally equates to a higher priced item than our normal work wear.

And so that has certainly helped in the last couple of years.

That's great.

On the direct sales side, is it fair to assume that we should pretty much expect negative growth through most of the year up until probably Q4 to give a tough comp in Q3?

So is negative the right way to think about it?

No.

I think it's going to get -- it's going to turn positive before the year is out.

Okay.

And one quick question on M&A activity, still really solid balance sheet and last quarter you talked about not seeing too many interesting opportunities.

Wondering if you could comment on how things are today.

I'm a little disappointed we didn't have more activity in the first quarter.

You see it was practically insignificant.

I'm encouraged a bit that there seems to be a little bit more activity now.

So I would expect there to be more acquisition activity over the course of the next couple quarters.

But with that said, it's certainly not at levels that we could actually do, given our balance sheet and our access to capital.

There still doesn't seem to be the kind of deals out there that would make sense of any size.

Great.

Thank you.

Andrew Steinerman, JPMorgan.

I heard mention of adding some routes, and I assume that's because a lot of our growth has come from new customers and new businesses and necessitating subdivided routes.

My question is, how long do you think those types of inefficiencies are going to remain?

And how much of an effect does that have on Rental gross margin?

That's a difficult question to answer because as you know, Andrew, it's all local business, so one operation may have -- be able to put a lot more business and move it to a route without much margin impact than another operation.

But generally let me say this.

We have decided that it is necessary to have more route capacity in order to properly take care of our customers and to give our service providers incentive to continue to maintain their business, work with their customers, treat them in the way that Cintas wants to treat their customers.

And so we think that while there may be a short-term margin impact in some operations, it will quickly be overcome by better lost business results and better improvement of growth with existing customers with other products and services.

Okay.

And with that in mind, do you have a sense of how much spare capacity you have in the routes?

There's no way I can -- we got so many thousands of routes, I do not know.

I would say that up until the last couple quarters, there was very little capacity because we were trying to do everything we could to maximize our routes and trying to get our return to better margins.

It's only because we've been able to do that and now were seeing the top line growth.

I would say we've freed up a little bit of capacity and then we're going to see some -- the CapEx, as Mike said, is $190 million to $210 million.

A lot of that is trucks to basically create that capacity.

So I'd say we're getting to more normalized levels that we would want to have in order to properly take care of customers and allow for more growth on existing routes.

Okay.

That sounds productive.

Thank you so much.

Scott Schneeberger, Oppenheimer.

Just a couple clarification questions.

In responding to, I think it was Shlomo's question on the aggressiveness in pricing and you said that, that had picked up, were you responding to in the uniform rental category?

Or was that more broad?

Could you take us around the horn a little bit with regard to pricing, please?

I think it's primarily in the uniform and facility services business.

And a little bit in the direct sale business.

I would say we've actually seen a slight improvement in pricing environment in the Document Management business.

And we never really had too much of an issue with First Aid and Safety and Fire.

That has been fairly steady.

Thanks.

And then on this concern over the third quarter, the fewer days, could you remind us what type of impact, rule of thumb on the numbers, two less days, would have year-over-year to help us with the models?

I see that the consensus has you going down in revenue Q2 to Q3 but EPS up.

Just want to discuss that dynamic to the extent you can a little bit more.

Thanks.

I'd have to -- I can't come up with off the top of my head, but basically just take the revenue run and divide it over the fewer days and it's a little less than or around 1% or so and that certainly has an impact on the margins.

I think if you go back, Scott, last year, we saw some nice improvements in the second and third quarter because we were really getting some good leverage.

I think if you go back a couple years, though, and looked from first to second to third, you would see some overall margin drop.

And I think those years are '10, ' 11, are probably some good indications of the drop.

Generally speaking, you have two less workdays in the first quarter, but you've got that depreciation and amortization that are the same per month because those are a monthly number.

You've got material cost that's generally on a monthly basis.

And so it certainly is an impact.

In the third quarter you've also got a resetting of payroll taxes.

Okay.

Thanks for that.

And lastly if I could ask, because you brought up a couple times and it was discussed last quarter, energy and the Carhartt product and fire resistance, it sounds like that's really moving.

Can you give us a feel for what type of contribution that's been as maybe as mix or contribution points to the growth?

Just want to get a feel for magnitude to the extent that you can share.

Thanks so much.

We're not going to give you the components of it.

The FRC business is a piece of our Rental business, and it has certainly been growing a little faster than the other Rental business, but the standard rental product line and facility services line also have been growing.

So I'm just not going to get into the habit of producing all of the different pieces for competitive reasons.

Thanks.

But the trend is still favorable?

You see that momentum?

The trend is still favorable.

Thanks so much.

(Operator Instructions)

Joe Box, KeyBanc.

I just want to flush out a comment from earlier.

I think, Mike, you mentioned that there is several new brochure rollouts that you're planning for the second half in your direct uniform business.

One, can you put some color around what those might be?

And two, I think you mentioned that you're looking for some positive growth in that business later in the year.

Are we looking for a normal low to mid-single digit growth rate?

Or could it potentially be more?

I'd rather not get into the customer specific information but we have a couple multi-million dollar rollouts in that business.

Generally in the uniform direct sale business, we expect -- although bumpy -- we expect generally a mid-single digit growth rate.

And I would expect that we'll be in that neighborhood for the year.

Okay.

For the full year?

For the full year.

Okay.

Great.

And switching gears over to merchandise amortization and just uniform rental margins, I think last quarter you guys were thinking that the cotton headwind could persist through the first half.

Obviously it was a factor this quarter, but potentially that could switch to a tailwind in the second half.

With cotton still trending below the five-year average, and maybe as you move to more of a normalization in new account sign-ups, could we be looking at maybe more of a benefit in the second half of this year than what you were previously thinking?

I don't think so, Joe.

And you're correct.

We said that the cotton headwind would go through mid-fiscal '13.

But as it rolls off and some lower cotton prices roll on, from quarter to quarter, it's a pretty small impact.

And the fact that we continue to add new business at pretty good clips means we'll continue to inject inventory.

And so I wouldn't expect that the change in the cotton would offset or really reduce the material cost from the continuing new business efforts.

Okay.

Thank you for your time, guys.

Gary Bisbee, Barclays Capital.

I wanted to follow-up on two things.

The comment around -- the commentary you gave around expanding the routes.

Is there any way to think about where the footprint is in all the offerings?

I know you offer uniform rentals everywhere, but where are you in shredding?

Where are you in the various first aid, fire, safety?

And maybe the one I feel like I have less understanding of, where are you on the various facility services businesses in terms of North American geographic coverage?

The facility service business pretty much coincides with the Rental business in North America.

So when we have an operation, a rental plant in a city, we typically are providing a similar level of all the facility services.

So I would say that coverage coincides with each other.

The Document Management business, the shredding side, I think the latest count, we are in probably around 80% of the top 150 MSAs.

So there's still some room to grow there.

Storage is much less than that.

It's only in the select few markets.

And then as far as the first aid and fire business, I would say the first aid business is in the majority of the MSAs, in the top 100 MSAs in the country.

The fire is about 60%.

Maybe in the top 100 MSAs.

So that's why our continued acquisition focus will be with filling out the footprint in fire and document shredding.

Okay.

And then -- that was the next question, what types of assets are you looking for on an M&A front?

Is there anything of scale at all out there?

Or is part of the problem just that there aren't?

I know for years in uniform you talked about a number of mid sized assets that were family-run and you would be an obvious acquirer if the next generation wanted to sell.

Do you see the market like that?

Or is it just that this is such a mom-and-pop market there's just not much --

It depends.

Let's talk about the businesses again.

In the uniform side, there's still lots of nice size companies out there in addition to the public companies.

There's some very good regional players that would be wonderful acquisitions if the price were right.

There's still a lot of good tuck-in acquisitions, small market -- not small market, but one or two market operations that would be very nice additions to Cintas, and we continue to pursue those.

It just hasn't been a meeting of the price expectations.

In document shredding, there certainly are some big players there.

And I think most of you know who those are.

Iron Mountain, Shred-it, Recall, all have very good sized shredding operations.

There still are hundreds and hundreds of small and some moderate regional type players there that we continue to have some discussions with.

So I think there will be some opportunities presenting themselves there.

The fire business, once you get -- you've got the big guy out there with Tyco's SimplexGrinnell business, I think they're getting ready to spin off, but there really are not a lot of big size players.

They are mostly small companies.

A couple of little regional guys, but that is more of just -- there's going to be a lot of little acquisitions that we'll probably be making in that space.

Okay.

Thanks a lot.

And we have no more questions in queue.

Thank you all for joining us.

We appreciate all the interest in Cintas.

The next release will be the latter part of December, right before the holidays, and we would expect to have the earnings call at that time.

So we look forward to speaking to you then.

This concludes today's call.

Have a wonderful day.