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Cintas Corporation (NASDAQ:CTAS)

F4Q09 Earnings Call

July 15, 2009 5:00 pm ET

Executives

William C. Gale - Chief Financial Officer, Senior Vice President

Michael L. Thompson - Vice President and Treasurer

Analysts

Ashwin Shirvaikar - Citigroup

Vance Edelson - Morgan Stanley

John Healy - North Coast Research

Analyst for Scott Schneeberger - Oppenheimer

Matt Gulati - Barclays Capital

Vishnu Lekraj - Morningstar

Greg Halter - Great Lakes Review

Justin Hautt - Robert W. Baird

William Lee - J.P. Morgan

Operator

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.

William C. Gale

Good evening and thank you for joining us tonight. The current recession continues to impact our customers in a significant way. As a result of the ongoing job losses, which have exceeded $5.5 million in the last 12 months, our revenues are showing a decline for the first time in 40 years. According to the U.S. Department of Labor, this job loss is 40% greater than losses experienced in 1982 and 2001 combined.

Today we announced fourth quarter revenue of $879 million, a 13% decrease from last year’s fourth quarter. As we announced in late May, fourth quarter results include a restructuring, impairment, and inventory valuation charge amounting to $54 million after tax.

Excluding this charge, earnings per diluted share were $0.38 in the fourth quarter, or $0.01 higher than the upper end of the range we provided in the May 29th announcement.

The economic conditions being faced by our customers continued to impact our revenue as customers reduce headcount. While we are adjusting our cost structure to meet these lower revenue levels, the severity and speed of the job reductions make it difficult to consolidate routes and plant capacity fast enough to offset the revenue declines.

However, we will continue to remain profitable and generate solid cash flow. Also, when employment begins to increase again, the marginal profitability of the additional uniform wearer or first aid user will be significant.

We are very pleased with our overall financial condition. During the fourth quarter, we generated over $185 million in cash from operating activities. During fiscal 2009, we paid off $165 million of commercial paper, paid our annual dividend amounting to $72 million, and yet increased our cash and marketable securities by $60 million.

As of May 31, 2009, we had no commercial paper outstanding and have cash and marketable securities of approximately $250 million.

During this economic slow-down, we continue to generate substantial cash flow and are able to keep our debt capacity available for opportunities that will arise for additional acquisitions or more rapid expansion throughout the world.

Due to the lack of visibility with the employment levels expected over the next 12 months, we are unable to provide any meaningful guidance and thus have chosen not to do so. We suggest that those of you making an estimate of our performance focus on the results experienced by Cintas in our fourth quarter and temper future results with your expectations of ongoing employment levels.

The Private Securities Litigation Reform Act of 1995 provides the 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.

Joining me today is Mike Thompson, Cintas' Vice President and Treasurer. Mike will now provide more details on our results and after his comments, we will open the call to questions. Mike.

Michael L. Thompson

Thank you, Bill and good evening. As Bill mentioned, total revenues were $879 million for the quarter, a 13% decrease from $1.01 billion reported for the fourth quarter of last year. Internal growth was also a negative 13%.

As Bill mentioned, all of our businesses are being impacted by the significant ongoing job losses and a difficult economic environment. Revenue was also negatively impacted by 1% due to a weaker Canadian dollar.

Before I discuss the quarter in more detail, as a planning note for fiscal 2010, the number of work days by quarter for next year are 66 works days in the first quarter, 65 in Q2, 64 in Q3, and 66 in Q4. As a reminder, each quarter in fiscal year 2009 had 65 work days.

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.

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 services are also included within this segment.

Rental uniforms and ancillary products revenue accounted for 74% of total company revenue in the fourth quarter. Within rental, based on fourth quarter revenue levels, uniform rental accounts were approximately 53% of the revenue. Dust control, which is mainly entrance mats, accounts for 22%. Hygiene, which is mainly restroom supply and cleaning, is 11%. Shop towels, 5%. And linen and other is 9%.

As a reminder, linen is mainly non-person specific garments such as aprons and butcher kits. We do not service many tablecloths, napkins, or bed sheets.

Rental revenues were $647.5 million for the quarter, a 9% decrease in revenues as compared to the fourth quarter of last year. Rental internal growth for the quarter was also a negative 9%.

This reduction is a direct reflection of the overall economic environment and also includes a negative 1% impact from a weaker Canadian dollar.

All four of our key revenue metrics continued to deteriorate in the fourth quarter, with a negative ad stop ratio having the most impact. This is not surprising, given the significant number of job losses that have occurred over the last 12 months. As compared to the third quarter, rental revenue decreased 4%.

Unemployment has almost doubled since the beginning of fiscal 2009 and was 9.5% at the end of June. The impact is even more dramatic with approximately two-thirds of the job losses occurring in traditional uniform wearing industries. These losses impact all of our metrics.

While we are doing a good job of retaining our customers, our ad stop ratio suffers due to lower headcount at our customers. Lost business increases as companies go out of business and/or do not pay their bills.

We continue to sell new business but average new customer size has decreased and new business is harder to obtain as prospects are resistant to new programs in this environment. Additionally, price increases become harder to obtain as customers control their spending.

While we are bearing the impact of our share of these job losses, our data indicates that our market share is not deteriorating. Consistent with that, our customer satisfaction levels remain very high and our customer retention levels are good. These factors provide us confidence that as the market solidifies, our results will improve.

Our other services revenue category on the income statement is comprised of uniform direct sales, first aid safety and fire protection, and document management operating segments.

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

Uniform direct sale revenue accounted for 11% of total company revenue in the fourth quarter, down from 14% in fiscal 2008. Within this segment, our global accounts division has a significant amount of business with the lodging, hospitality, and gaming industries. These industries continue to suffer and are cutting costs and reducing headcount.

While our uniform direct sale business is directly impacted by headcount, it is also impacted by discretionary spending. Given current conditions, very few new property openings or refresh programs are occurring. Refresh programs are sales which occur when customers change or refresh their uniform design at a property or throughout their organization. During economic downturns, these discretionary types of spending tend to slow or even stop.

The current economic downturn is the most significant we’ve experienced since entering this business in the 1990s. This segment’s sales for the fourth quarter were down 33% from a year ago and internal growth was also a negative 33%.

In our first aid safety and fire protection services business, we sell and deliver first aid products, safety products, and automatic defibrillators to our customers. We also provide safety training to their employees.

Within fire protection, 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.

First aid safety and fire protection accounted for 9% of total company fourth quarter revenue. During the quarter, revenues within our first aid safety and fire protection services operating segment decreased 21% and internal growth was negative 22% in the fourth quarter.

The first aid and safety revenue in this segment is reliant on customer employee headcount. As customer employment levels decrease, there are less people requiring first aid products such as bandages and tablets and less safety products such as hard hats and eye protection. This situation is compounded, given little business expansion or new construction, which normally helps further drive safety sales.

On a positive note, our on-site training program revenue was positive for the year, as our customers reduce their headcount, they rely on us more to provide their first aid training. We continue to develop into the third-party first aid and safety consultant and provider.

Fire protection revenue continues to decline, primarily in installation revenue, due to the lack of commercial construction and expansion. Customer facility closures and consolidations are also impacting fire protection revenue.

We continue to exit the installation business, other than a few markets where we have a sufficient presence in installation infrastructure. Our focus on fire protection services has been and continues to be on the test, inspection, and repair of portable fire extinguishers, exit lighting, and fire suppression systems.

Revenue for this portion of fire protection services was significantly less impacted by the economy than the installation portion of the business.

Our document management services operating segment is comprised mainly of document shredding services, although we do have storage and imaging capabilities. Document management represents 6% of fourth quarter total company revenue.

As with many commodities, recycle paper prices rose dramatically during fiscal 2008, providing additional revenue for our shredding business. Prices reached their peak in April of 2008. Since that time, paper prices have fallen back to more historical levels and prices have been fairly stable over the last six months. Excluding this impact, our document shredding service and purge business provided internal growth of 17%. Including recycled paper, internal growth was a negative 4%.

Total growth of document management, including acquisitions, was a positive 1% for the quarter.

During fiscal 2008, we expanded our document management business to Europe through an acquisition in The Netherlands, and in fiscal 2009, we further expanded into Germany through another acquisition. Both operations continue to meet expectations and we continue to look for additional expansion opportunities in this business, both domestically and abroad.

Fourth quarter total company gross margin was 38.1%. However, this margin included the inventory valuation portion of the restructure, impairment, and inventory valuation charge. As indicated in the release, the total after tax charge was $54 million. On a pretax basis, the charge was $86.6 million. This is broken down as follows -- $48.9 million is the loss on impairment of long-lived assets and appears on the face of the financial statements. The majority of this charge relates to the write-down of real estate and equipment in conjunction with plant consolidations under the restructure plan; $10.2 million is for restructuring charges, including lease termination, severance, and other direct costs related to the rental plant consolidations. This amount also appears on the face of the income statement; $27.5 million is for the inventory valuation charge. This charge established an appropriate reserve on inventory based on current customer demand. The inventory valuation charge is included as a charge to cost of goods sold; $8.4 million of the charge is included in cost of rental uniforms and ancillary products and $19.1 million is included in cost of other services. The $19.1 million charge included in cost of other services is the sum of a $16.1 million charge in uniform direct sale and $3 million charge in first aid safety and fire protection services.

Excluding the inventory valuation charge, total company gross margin increases from 38.1% to 41.2%. This is 170 basis points lower than the total company 2008 fourth quarter margin of 42.9%. The decrease is due to the impact of lower revenue, partially offset by energy cost improvement.

Despite a $30 million decrease in total revenue from the third quarter, the 41.2% adjusted total company margin is in line with the 41.4% margin earned in the third quarter.

Rental margin excluding the inventory valuation charge was 43.6%, while other services adjusted margin was 34.5%.

Energy costs for the company were 2.7% for the quarter, as compared to 4% in last year’s fourth quarter, due to lower delivery fuel and natural gas expense. Energy costs for the third quarter were 3.1%. This 40 basis point improvement was mainly through lower natural gas expense.

While energy pricing plays a large part of the improvement year over year and quarter to quarter, we are also gaining efficiencies through more efficient routing structures and other energy conservation measures.

Rental gross margin was 42.3% of revenue for the quarter, but 43.6% when excluding the inventory valuation charge. The 43.6% adjusted gross margin is a 30 basis point decrease from the fourth quarter of fiscal 2008 and a 20 basis point decrease as compared to last quarter. The decrease was due to the effect of lower revenues on material costs.

When garments, mats, and other rental items are placed into service, they begin amortizing over their useful life, generally 18 months for garments and 36 months for entrance mats. This amortization period is not adjusted or halted. This means that during a period of decreasing revenue, material cost as a percent to revenue will typically increase due to inventory injections that occurred in prior months when the business being supported was at a greater level.

Material cost in dollars was consistent as compared to last year’s fourth quarter and to last quarter but on a percent of sales basis, it increased 180 basis points from the fourth quarter of fiscal 2008 and 100 basis points in the third quarter, primarily due to these lower revenue levels.

As mentioned earlier, energy costs were lower in the fourth quarter, which offset most of this increase in material costs.

In addition, while plant and delivery labor as a percent of sales were flat, the company did reduce those labor costs by $12 million compared to the fourth quarter of fiscal 2008 and $7 million as compared to the third quarter, as we continue to bring our cost structure in line with current revenue levels.

Excluding the restructured charge, other services gross margin was 34.5% for the quarter, as compared to 40.5% in last year’s fourth quarter, but in line with the 34.7% in the third quarter.

The decrease compared to the prior year is due to the decrease in uniform direct sale and first aid safety and fire protection revenue and to a lesser extent, the reduction in recycled paper prices being received in document management.

As compared to the third quarter, when excluding the restructured charge, uniform direct sale and document management margins improved 100 basis points each but the improvement was offset by deterioration in the fire protection services within first aid safety and fire.

Selling and administrative expenses were 28.9% of revenue. We have reduced SG&A expense by $25 million as compared to last year’s fourth quarter, including a $6 million reduction in G&A labor and a $10 million reduction in total employee related costs, such as payroll taxes, workers compensation, and medical costs.

However, the sudden and rapid decrease in revenue caused a 120 basis point increase in SG&A on a percent of sales basis. We continue to aggressively manage our cost structure to bring these costs in line with current revenue levels.

Likewise, SG&A costs decreased $3.4 million as compared to the third quarter but increased 60 basis points on a percent of sales basis.

Within SG&A, our bad debt increased approximately $6 million over the fourth quarter of last year, primarily due to increased reserve requirements for fire installation customers. Certain customers in this line have increased financial difficulties and some are facing or have entered bankruptcy proceedings. This is another reason we continue to exit much of this business.

We also increased our bad debt reserve for specific rental customers due to bankruptcies, including balances related to certain automotive industry related customers. Despite these increases, our bad debt was 0.5% of revenue and consistent with bad debt expense for each of the last three quarters.

Net interest costs this quarter of $11.7 million was down slightly as compared to $12.1 million in last year’s fourth quarter and $11.9 million last quarter. The reduction was due to lower outstanding commercial paper.

Our effective tax rate was 58.8% for the quarter, which reflects the effect of the restructure. The full year effective tax rate was 37.4%, which is in line with previous estimates.

Our balance sheet continues to be strong. Our current ratio was over 4-to-1 at May 31st, and our equity has improved to a record $2.4 billion. Cash and marketable securities increased $58 million over May 31, 2008, and by $98 million since February 28, 2009 due to strong cash flow.

The $120 million of marketable securities at May 31, 2009 are all held in Canada. These funds, which are generated from operations there, are held in short-term conservative government investments and are currently being held for investment opportunities outside the United States.

DSOs on accounts receivable were 42 days. We continue to actively manage our accounts receivable in order to lessen any impact from current economic conditions.

New goods inventory levels decreased $36 million from May 31, 2008 and $50 million from February 28, 2009. $27.5 million of the increase is the inventory valuation charge taken in the fourth quarter. The additional $8.5 million reduction from last year-end and $22.5 million reduction since the end of the third quarter is through aggressive inventory management in conjunction with lower sales volume.

Uniforms and other items in service decreased $35 million as compared to last May and $17 million as compared to February. The negative ad stop ratio allows us to pull a greater percentage of used garments from our rental operation stock rooms and in conjunction with lower new business, reduces the need for additional new garment injections.

Assets held for sale of $16 million on the balance sheet represents the value of real estate and equipment for consolidated operations under the restructure. Also as noted in the supplementary information included with the earnings release, no impairment charge was required or recorded for good will or other intangibles.

Long-term debt at May 31, 2009 was $787 million. All of the outstanding debt at May 31st was fixed rate debt and it had an average interest rate of approximately 6%. Total debt as a percentage of total book capitalization was 25%. Net debt, or long-term debt less cash and marketable securities as a percent of total capitalization was 18%.

The company’s current assets exceed company total liabilities by over $200 million. This does not include the current real estate and equipment value, which on an historical cost basis net of depreciation was $915 million.

Our cash flow remains strong, with cash provided by operations totaling $524 million and free cash flow of $363 million, which is an increase of $11 million. Capital expenditures were $160 million for the year. This included approximately $43 million that was spent in conjunction with certain IT infrastructure capital projects, including implementation costs of an SAP, ERP financial system. Of the $43 million, $3 million was spent in the fourth quarter.

Excluding capital for these projects, the $117 million in capital expenditures was invested as follows: $87 million was invested in the rental division. These expenditures were primarily for ongoing maintenance CapEx but also included completion of a couple of rental plans which were under construction earlier in the year. Last year we spent $140 million in rental division CapEx, so this represents a $53 million reduction this year; $2 million was spent in uniform direct sale, as compared to $7 million last year; $6 million in first aid safety and fire as compared to $12 million last year; and $22 million in document management as compared to $31 million last year.

While the rate of growth has slowed in the document management business, the service revenue continues to grow at a double-digit rate. We continue to invest growth capital mainly in the form of mobile shredding trucks and industrial shredding equipment.

In fiscal 2009, we spent $31 million on strategic acquisitions, mainly of document management businesses. We continue to evaluate acquisition candidates but valuations need to continue to come in line with today’s market realities. We have sufficient cash and access to capital were an acquisition opportunity to present itself at the right valuation.

Despite a difficult economy, which caused lower revenues and earnings, our strong cash flow, combined with lower capital expenditures and fewer acquisitions, allowed us to fully pay off our commercial paper balance as of May 31, 2009. Our $600 million commercial paper program remains in effect through February of 2011.

In addition to paying off over $155 million in debt during the year, we also increased our annual dividend payment to shareholders, paying $72 million during the fourth quarter. This increased dividend demonstrates our confidence in cash generation despite a difficult economy.

Our cash flow and balance sheet are providing us the financial stability to address current economic concerns while enabling us to be poised for future expansion when market conditions improved.

Thank you and I will now turn the call back over to Bill.

William C. Gale

At this point, we’ll be happy to answer any questions that you have, so Jessica, if you want to explain how to do that, we will start.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from  Ashwin Shirvaikar.

Ashwin Shirvaikar - Citigroup

My first question is actually about the sustainability of the lower cost structure as revenues eventually come back. So to what extent would you expect costs to go back up with revenues in an eventual recovery? If you could take us through the math or the thought process and maybe some examples of what kind of cost you are taking out?

William C. Gale

Okay. Well, I guess let’s assume that there’s no significant change in cost components like energy but assuming that, what you will see initially is as we add -- as our customers add back employees, we will begin to see the marginal profitability of that additional revenue to improve margins going forward.

Now once you -- your top line growth that’s caused by new business continues to go up, you are going to start injecting more garments but we believe that the margins for the business segments will actually improve in an improving economic environment.

Ashwin Shirvaikar - Citigroup

Would you expect the profitability of the rental segment to get back down to the 16%, or possibly higher level in the next couple of years?

William C. Gale

We would -- assuming again the basis that I said on energy costs, as an example, we absolutely believe we can get our margins back to more historical levels.

Michael L. Thompson

A side note on that as well, Ashwin, is that with the restructure project, we were very careful that we were not taking all our capacity out of markets. We want to ensure that we have the ability to grow when the market does turn around.

Ashwin Shirvaikar - Citigroup

Okay, and a couple of housekeeping questions -- one is, could you provide the split for the inventory adjustment charge between all the various segments?

William C. Gale

Mike can give you that again.

Michael L. Thompson

The piece -- it was $27.5 million was the total inventory valuation charge. Of that, $8.4 million was in the cost of rentals and 19.1 is cost of other services. Of the 19.1 in cost of other services, 16.1 is in uniform direct sale and $3 million is first aid safety and fire.

Ashwin Shirvaikar - Citigroup

And with regard to document management, the impact of paper prices obviously is there. You’ve said in the past that you had a contract that went through the end of the fiscal year for paper price sales, for paper sales. What’s the status of the renegotiation? What kind of pricing are you getting as you go forward?

Michael L. Thompson

We actually indicated it goes out through part of this fiscal year, so we are currently in those negotiations but that contract still remains in place at this point in time.

Ashwin Shirvaikar - Citigroup

So the old contract stays for now?

Michael L. Thompson

Yes.

Ashwin Shirvaikar - Citigroup

Okay. Thank you.

Operator

Our next question comes from Vance Edelson from Morgan Stanley.

Vance Edelson - Morgan Stanley

Thanks a lot. In terms of moving out of the fire installation business, you know, even though the bad debt is still pretty low on a percentage basis, at least company-wide, if in the coming years building activity were to pick up again, is that something you could easily get back into, or would you even want to?

William C. Gale

At this point in time, I would say that we would only remain in that business in those markets where we have a -- where we are going to continue to have a significant presence. I doubt if we would decide to expand in any aggressive way in the installation business, even if economic conditions improved.

Vance Edelson - Morgan Stanley

Okay, and regarding expansion around the world, do you see attractive M&A opportunities right now? In other words, have valuations come down such that now is the time, or close to being the time, or would you rather wait until global growth prospects are stronger?

William C. Gale

Vance, I’d say right now, other than in a very few selected situations, the majority of valuations have not come down to the appropriate levels to justify an acquisition.

Vance Edelson - Morgan Stanley

Okay, and turning back to the domestic side, are there any areas for investment going forward that you think are likely to turn sooner, a bit more early cycle when you look at your different verticals, or the different business lines in the area that you are thinking over the next 12 months you might actually be investing in?

William C. Gale

Well, I think it all depends on where do the jobs stop declining and where do they start coming back, and we are poised to take advantage based on some of our businesses that we are in where those job -- that job growth may be. For example, if it’s in healthcare, you know, we have direct sale programs in our document management business and even some of our first aid and safety businesses lend themselves very well to the healthcare market, so we are ready to take advantage of that.

In the hospitality and gaming businesses, we’re certainly the largest company in uniform supplier in those businesses and we’ll certainly be the one to take advantage of any growth in that potential.

You know, I think in the uniform rental side, you know, our strategy has been to broaden our customer base over the last several years to take advantage of where the economy is going, so I think that we will be in a position to take advantage of any improvement that does happen, regardless of which business it’s in. I just at this time can’t predict where that’s going to be or how quickly that’s going to happen.

Vance Edelson - Morgan Stanley

Okay, appreciate the color. Thanks.

Operator

We’ll now go to John Healy from North Coast Research.

John Healy - North Coast Research

Good evening. A strategy question for you, Bill -- after the last economic downturn, you guys took the opportunity to move from I guess the uniform professional into the service professional. With the balance sheet as strong as it is today and the cash flow that you guys are generating, is there any appetite to begin to kind of I guess further that move into the service professional world, or are you at a level where you guys feel like you are going to remain conservative with the investments? I mean, is there an appetite I guess to begin to try to roll out more services or pilot more services and kind of use this opportunity to try to test things out?

William C. Gale

Well John, despite the economic downturn, our company continues to evaluate other services that we feel have some potential and that we could have a competitive advantage. So those activities are continuing, and I would say that we will continue to look for opportunities to become more of a service professional as long as it meets the criteria that we’ve talked about over the years of being relatively fast-growth businesses, high margin businesses, things that we could get into, you know, and develop a presence and move the needle -- businesses that may be used by a lot of our other customers. So that criteria continues.

We will always be a relatively conservative company in that we are not going to jump into something in a major way until we have proven it to ourselves that it makes sense, but let me tell you that there are several things going on, some of which are very promising right now that we think could enable us to just expand our offerings as the economy begins to improve.

John Healy - North Coast Research

That’s encouraging. And then you made the comment, Bill, that the average customer that you guys service continues to become smaller. I guess going forward, I have to imagine that the days of servicing -- finding new sales in terms of the 500 employee manufacturing facility, there’s probably not a lot of those opportunities but a lot of opportunities going forward, I imagine, on smaller businesses. Do you see that as a benefit to margins, selling to smaller customers rather than to bigger customers over the long run? Or is that something that is not necessarily a benefit to operating margins I guess going forward?

William C. Gale

Well, you know, keep in mind, all of our customers have always been relatively small customers. The average stop typically has always run between eight and 12 employees. Yeah, we have large manufacturing or large distribution type operations but our bread and butter has always been the smaller -- basically the smaller company or smaller stops of bigger companies. So that strategy doesn’t change.

I think the opportunity we have because of our broad offering of products and services is probably going to be more appealing to the smaller business, so I think that we will become a more valued provider in a number of different things to the small business owner as they look for ways to cut their cost and look for ways to make sure that things are done properly, that they are maintaining a safe environment, maintaining the proper image for their employees.

So the growth that we hope will begin to take place here soon in the economy will be driven by small business and that really has always been our sweet spot, so I think we are probably in even a better position now than we were 10, 15 years ago.

Michael L. Thompson

And with that, I think we’ve been battling the manufacturing job loss in the United States for years now and I think Bill’s comments were more that because of the job loss, we’re not losing that many more customers. It’s mainly that the customers we have are smaller because they are all losing positions. We expect those to grow back but I agree with your point, John, that there aren’t as many large factories out there that are going to sprout back up in the near future.

John Healy - North Coast Research

Got it. And then just last question, was there any sort of identifiable trend during the quarter in terms of the declines in revenue? You know, was it steady throughout the quarter -- you know, did it kind of accelerate either at the front-end or the back-end of things?

William C. Gale

Well, you know, you have changes week to week, John, but as we look at trend, I’ll tell you, it was relatively steady, it was probably a little heavier in the early part of the quarter and then it might have seemed to get a little bit better. But it’s still an ugly situation out there with regard to job losses, so it continued pretty much through the quarter.

John Healy - North Coast Research

Okay, great. Thank you so much.

Operator

We’ll now go to Scott Schneeberger with Oppenheimer.

Analyst for Scott Schneeberger - Oppenheimer

Good afternoon. This is [Alice] for Scott. I guess first of all, can you guys help clarify how much dollar savings that you are having fiscal year ’10 from all the cost reductions from the employment reduction and the closure of locations?

William C. Gale

We are estimating that the impact on fiscal year ’10 from the actions that we took right at the end of our fiscal year ’09 are going to add about $0.03 to $0.04 a share for the year. Now, part of the issue that we have is, as Mike talked about this inventory valuation charge, it’s very difficult to predict when that impact would happen, so what we are talking about when we say $0.03 to $0.04, that’s primarily as a result of this reduction in valuation of some of these fixed assets and the severance costs associated with the termination of certain employees, but that’s the number you are looking for. It’s about $0.03 to $0.04.

Analyst for Scott Schneeberger - Oppenheimer

Okay, thanks for the color. And in terms of capital spending, could you provide some colors for the guidance for the next year and what will be your primary areas of investment for fiscal ’10?

William C. Gale

At this point, we are not going to give specific guidance with regard to capital spending but we will tell you that it will be less than what was spent this year because the majority of the information technology spending on the new ERP system that Mike talked about is pretty well behind us for right now.

But the level of capital spending will vary depending on how quickly the economy recovers, so if the economy recovers quicker, then we would tend to spend a little bit more money buying trucks or expanding, buying equipment. But if the economy continues to be relatively sluggish, then that capital spending, we’ll adjust it to be lower. But I would say for planning purposes, you certainly can assume that it will be less in fiscal ’10 then it was in ’09.

Michael L. Thompson

And we will continue, just like we did this year, to infuse capital into document management, as long as it continues to grow double-digit, as it did this year.

William C. Gale

We always have maintenance capital. We have to replace trucks, we have to replace some equipment here and there and as Mike said expand, you know, document management should continue to grow and expand. But beyond that, as far as new plants, we don’t anticipate a lot of new plants being built and there’s not going to be a lot of new trucks needed other than to replace those that wear out.

Analyst for Scott Schneeberger - Oppenheimer

All right. Thank you, guys.

Operator

(Operator Instructions) We’ll now go to Gary Bisbee from Barclays Capital.

Matt Gulati - Barclays Capital

This is Matt Gulati on behalf of Gary Bisbee. Just a quick question -- I was wondering if you could provide some commentary on kind of the U.S. reorganization of the automotive industry and what kind of impact that has on both the uniform business, as well as some of the ancillary offerings?

William C. Gale

Well, the biggest impact that we are going to probably feel is going to -- has to do with what happens with the dealership networks. You know, Chrysler has announced a significant reduction in the number of their dealerships, as has General Motors. A lot of the General Motors dealerships haven’t yet been publicly announced, so it’s hard for us to say what that would be.

But offsetting that is going to be determined by what these owners of these dealerships do. Many of them have indicated that they may remain in business as a repair shop, which actually will be to our benefit, because that’s primarily what we are servicing. You know, we have had some impact of some of the plant shut-downs by the big three and some of the supporting industries to those big three. That stuff may not come back, so that may be a permanent loss.

But the vantage that Cintas has always had is that we have a very diverse customer base. We have over 800,000 customers that we are providing different services to. No one customer amounts to any significant amount of our revenue -- in fact, no one customer amounts to more than one-half of 1% of our revenue. So even with the significant reduction in employment in that industry, you know, it’s not going to have a detrimental impact on the company. We are going to be able to continue to service a lot of the industry that fixes cars, the after market, that’s going to continue. And it’s -- as far as the exposure we had to new auto construction is relatively insignificant.

Michael L. Thompson

And as well, you talked about dealerships, it’s interesting too in that we’ve already been impacted to some degree in that many of the sales professionals have changed to where rented uniforms, and obviously those professionals, the job ranks have been squeezed quite a bit over the last few months. And then you start talking about the back of the house with the mechanics, that work will still need to get done in some fashion.

So while there will certainly be an impact, it’s difficult to quantify, just because that work that they are doing in the back of the house, so to speak, from the mechanic side, will end up somewhere.

Matt Gulati - Barclays Capital

Great, thanks for that. And then if I could ask a follow-up -- could you quantify or provide an approximate amount, I guess, the level of paper pricing? And also what type of impact that paper pricing has on the document management? I guess what percent of overall document management is made up from the sale of paper?

William C. Gale

We haven’t disclosed that level of detail at this point. Now, Mike did talk about the impact it had on the overall growth rate. I believe the number was -- you know, without the impact of the paper price reduction, the growth of the document management business was 17%; with the paper prices, it was a negative 1%. But we -- you know, for competitive reasons, we don’t want to disclose publicly what our price is and we are concerned that people could back into what our contract is and that’s all very proprietary and we have to keep that quiet.

Matt Gulati - Barclays Capital

Okay, fair enough. Thanks for your time. Appreciate it.

Operator

We’ll now go to Vishnu Lekraj from Morningstar.

Vishnu Lekraj - Morningstar

I want to talk a little bit more big picture here, looking out maybe two, three years -- your core competency has been uniform rental, obviously but looking at your newer lines of business, the historical [model] here over the last year-and-a-half, given the recession, how do you guys view this and how should we be thinking about the profitability and the return of these businesses over the next couple of years and if they are going to ramp up to a level where you’ve had in regards to the rental uniform business?

Michael L. Thompson

I think first in response to that, I’m not sure that the other businesses have suffered dramatically, other than uniform direct sale. Certainly first aid has been impacted by less traffic and the installation business, the construction industry has hurt us there and we are exiting that business.

The document management has continued to grow very well and our service side of the fire business is, while it was down a little bit during the year, it was not down dramatically. So I think our emerging business has continued to do pretty well, but certainly just like uniform rental, the economy has impacted them.

As jobs come back, we expect them to come back in that business as well as in uniform rental and we continue to put all of our efforts into maintaining those customers so that we can gain that market share when they do come back.

William C. Gale

I’d say we actually feel very confident that as the economy improves, businesses and our customers are going to continue to look for ways to get things done in their operations without having to add people, without having to worry about it themselves, and we are going to be the company that’s going to be poised to do a lot of that and do it professionally, handle a lot of -- you know, the small details, not just uniforms but facility services, first aid and safety, fire services, document shredding services, and the other things that we are still working on, and we believe that that will enable us to resume very good growth rates into the future.

Vishnu Lekraj - Morningstar

So on a profitability level, on the return level in terms of investment, would these newer businesses get on par with what you guys have done with rental uniforms?

William C. Gale

Oh, yes. We’ve always stated that other than the direct sale of uniforms, all of these other businesses when they get to the appropriate scale in a market, have profitability levels equal to or greater than our uniform rental business.

Michael L. Thompson

That’s a very important point that it’s a local operation that needs to get the size. I think many times, people look at the division and say oh, it’s getting big but you’ve got to look at the individual location size from our perspective and it has to get up to critical mass. And we can tell you that when those locations do, in first aid, fire, and document management, the profitability is there.

Vishnu Lekraj - Morningstar

Okay. One more quick question for you -- I think this has been touched on previously but given that employment here is expected to be at depressed levels, or levels below pre-recession levels for the next couple of years, how do you guys plan on maintaining the profitability within your route distribution network, in terms of --

William C. Gale

Well first off, I don’t know if it will remain at these levels or not, so we are going to be prepared to react to whatever situation that comes our way and the way we are going to do that is the way we started to do that over the last nine months, is that we will do route consolidations, we will do plant consolidations, if necessary. We look for other opportunities to reduce overhead in our operations and in our corporate office, so our -- we’ve already started this process and we can -- we’ve got a very flexible organization that enables us to adjust for these type of things and it just takes us a while to get there.

So as Mike said, you know, material costs, the uniforms, once you inject them into a new customer and then if that customer reduces headcount, we bring those garments back into our stock room and if we don’t have another place to use them, then we continue to bear the cost of that in our cost structure because part of it is the way we, you know, through our conservative accounting that we deal with this.

So I think that over time, we can adjust our cost structure to the revenue levels that we will be dealing with because the company wasn’t -- it wasn’t too long ago we wrapped these type of revenue levels.

So we know what to do, we just have to be careful you don’t overreact because you want to be able to take advantage of the improvement in the economy whenever that takes place, which we believe certainly is going to take place -- we just don’t know when.

Michael L. Thompson

Certainly what would help is if the job loss just doesn’t continue to deteriorate. If we would get to an unemployment level that’s stable, then we believe we can start recovering from that and then beyond that, when you get to growth, a good example for uniforms, for example, is on a typical customer, if you he had 11 wearers six months ago and we’re down to nine today, you’re dropping about 18%. Well, if we go back to just one additional wearer in the next six months, you get 12% growth out of that 11% growth. And the marginal profitability of that growth is significant because you were already stopping the truck, in many times you have the garments already in your stock room, you are already paying the driver, the production is pretty easy to pick up on, so the profitability can really pick up quite quickly.

Vishnu Lekraj - Morningstar

Great. Thanks, appreciate it.

Operator

And we’ll now go to Greg Halter with Great Lakes Review.

Greg Halter - Great Lakes Review

Good afternoon and thanks for taking the questions. I wonder if you could comment on overall pricing for the -- especially on the rental side, and then on the cost side, the hangars and medical costs, which have at least during fiscal ’09 appeared to be an issue at certain points in the quarter, of the year.

William C. Gale

Well pricing has certainly become a much more difficult situation with regard to getting price increases through because obviously with CPI down, there has been -- you know, and due to a lot of customers having their own issues, we’ve had to basically work with our customers to keep price increases in line.

New business pricing remains very competitive. It always has. There have been certain markets where it’s become even more competitive but we continue to evaluate the business based on the future profitability of that business to the company and the growth of that customer, and we will react accordingly but we are not going to just continue to chase prices down if a competitor decides that they want to try to do that in a particular market.

With regard to some of the cost issues, I would say that the hanger prices have now returned back to more normal levels, after the run-up that we saw about a year ago. They are back down to more normalized levels and the -- what was the other one that you asked, Greg?

Greg Halter - Great Lakes Review

Medical.

William C. Gale

Medical costs were relatively flat on a percent of sales basis, while medical costs continued to increase, some of the programs that we have put in effect are having an impact. Of course, we have lower headcount, which that is helping us. And you know, it’s something that we are concerned about in the future. We continue to try to make sure that we balance providing our employee partners with the proper level of medical benefits while at the same time making sure that we are not, you know, spending too much money on it from a company and a shareholder perspective. So it’s -- but I would say it’s been staying in line on a percent of sales basis over the last 12 months.

Greg Halter - Great Lakes Review

Okay, and I wondered if you could provide some commentary on the SAP installation, if you’ve turned on any of the different features of that yet and how you would judge it going so far?

William C. Gale

Well, we have not turned on any features yet. Our plan is that during this fiscal year, certain parts of it are going to be turned on. So far we are happy with the project and what we are seeing and we are still in line with our cost estimates of what it was going to take to put this first couple of phases in.

So again, we haven’t converted anything but we will be converting something this fiscal year.

Greg Halter - Great Lakes Review

Okay, and I know you are not giving the commentary on the CapEx but relative to depreciation and amortization, I think it was $200 million in fiscal ’09, would you expect that level to be higher or lower, especially with some of the IT CapEx that has a -- probably a quicker depreciation rate than other things?

Michael L. Thompson

I don’t think it would move materially because of the restructure pieces coming down. We don’t have an exact number for you at this point but we don’t expect a significant movement.

Greg Halter - Great Lakes Review

Okay, and I know it’s a board decision but any commentary you could provide on the company’s dividend policy, if you would like to keep that moving upward, as has been history for I think 30-plus years?

William C. Gale

Well you know, I can’t say, Greg, for sure. I know the board, it does look at that very closely. It’s an annual decision. As you know, we only pay it on an annual basis but the board felt very confident this past spring to raise the dividend and I would think that they will take into consideration current year results, as well as the expectations going forward and it would be nice to hold on to that continued increase but I can’t guarantee anything at this point in this environment, so we’ll just have to see how things go.

Greg Halter - Great Lakes Review

Okay, and one last one for you -- it may be too early in the year, but can you remind us what the breakdown is by industry, especially on the rental side?

William C. Gale

You mean as far as what our percentage is in the various industries?

Greg Halter - Great Lakes Review

Correct.

William C. Gale

We really don’t have anything more than what we’ve provided before. That’s something that is not necessarily done at any one point in time. It’s looked at periodically so I really can’t give you any update to that right now.

Greg Halter - Great Lakes Review

Okay. Thank you.

Operator

Our next question comes from Justin [Hautt] from Robert W. Baird.

Justin Hautt - Robert W. Baird

Actually, all of my questions have been answered except for one quick housekeeping one -- back to the scrap paper prices, I know you guys mentioned in the past you had some price floors on those contracts and I guess I was just wondering with the sequential up-tick we’ve seen on the prices, are we still below those floors or are we kind of moved past that?

Michael L. Thompson

We are still slightly below.

Justin Hautt - Robert W. Baird

Okay. Thank you very much.

Operator

And we’ll now go to Andrew Steinerman from J.P. Morgan.

William Lee - J.P. Morgan

This is William Lee for Andrew Steinerman -- just one quick clarification; in terms of the internal growth for document management, including paper prices, was that a negative 1% or negative 4%?

Michael L. Thompson

With paper prices, the internal growth was negative 4%, the total growth of the division, including acquisitions, was positive 1%.

William Lee - J.P. Morgan

Okay, great. Thanks.

Operator

And there are no further questions. I would like to turn the conference back over to you, Mr. Gale, for any additional or closing remarks.

William C. Gale

Well, thank you, everyone for joining us this evening. We are -- we appreciate your continued support. We will be planning on releasing our first quarter earnings some time in the mid to latter part of September. Good night.

Operator

This concludes today’s presentation. Thank you for your participation.

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Source: Cintas F4Q09 (Qtr End 5/31/09) Earnings Call Transcript

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