G&K Services Inc. F2Q10 (Qtr End 12/26/09) Earnings Call Transcript

| About: G&K Services, (GK)

G&K Services Inc. (GKSR) F2Q10 Earnings Call January 26, 2010 11:00 AM ET


Doug Milroy - Chief Executive Officer

Jeff Wright - Senior Vice President and Chief Financial Officer

Shayn Carlson - Director of Investor Relations


John Healy - North Coast Research

Nate Brochmann - William Blair

[Justin Hauck - Unidentified Company]

Mike Hamilton - RBC Capital Markets


Good morning. My name is Pali and I will be your conference operator today. At this time, I would like to welcome everyone to the fiscal 2010 second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions)

I will now turn the conference over to Mr. Shayn Carlson, Director of Investor Relations. Sir, you may begin.

Shayn Carlson

Good morning. Thank you for joining our call today to discuss fiscal 2010 second quarter results. With me today is Doug Milroy, our Chief Executive Officer, and Jeff Wright, our Executive Vice President and Chief Financial Officer. After a discussion of second quarter results, we will open the call for any questions.

Before we begin, all statements made on this call concerning our intentions, expectations, or predictions about future results or events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements reflect our current expectations or beliefs and are subject to risks and uncertainties that could cause actual results or events to vary from stated expectations, which could be material and adverse. You are cautioned not to place undue reliance on these statements and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Information concerning potential factors that could affect G&K in its future financial results and operating performance are included in our Annual Report on Form 10-K after the fiscal year ended June 27, 2009. A replay of this call will be available starting today at approximately 1 pm Central Standard Time and continuing through February 25. You may access of the replay by visiting the Investor Relations section of our Website.

At this time, I will turn the call over to Doug.

Doug Milroy

Thanks Shayn. Good morning everyone. Thank you for calling in today. We appreciate as always your interest in our company. As in the past, today I would like to cover three things. I’d like to briefly recap our second quarter. I’d like to remind you of the key elements of our game plan and then, third update you on the progress of our game plan, give you a couple of specific examples as we did last time.

So if we first look at the second quarter, total revenue for the quarter was $206 million versus $242 million in the same quarter prior year or down over 14%. While we are obviously not happy with that, within these results there is, again some positive news. If you compare sequentially to Q1, total revenue came in consistent with our expectations it was down less than 1% sequentially.

So, again, that is the least sequential decline in total revenue that we have seen since employment began its steep downward trend. On the earnings side we reported $0.39 a share and if you adjust that for the divestiture activity we talked about in our press release its more like $0.31. I think it makes sense to further adjust it for the lower than expected tax rate, so that essentially makes it $0.27 a share.

So, again that was consistent with our expectations and increased sequentially from the $0.22 a share in the prior quarter. That is our second consecutive up tick NOI margins. We were up 60 basis points from Q1 and I will remind you we were up 60 basis points sequentially in Q1 from Q4, which is entirely consistent with our game plan and we repeatedly said earning our right to grow, focusing first and foremost on improving our profitability.

So two quarters clearly don’t like a trend, but nonetheless it helps confirm the direction of our new game plan and, importantly of course at the same time, our cash flow remains very strong. Jeff will take you through the rest of the financial details in a few minutes. The second thing I’d like to do today is recap our game plan especially as a reminder, but also for any new investors we have on the call.

Late last summer, we launched a new game plan for reshaping the company and taking it in a different direction. It has four key elements. The first is a redoubling of our focus on customer satisfaction. Now again, clearly we already have a very high level of customer satisfaction with 170,000 customers.

What we’re doing is taking it to a whole new level and ensuring that every element of the company is focused on understanding and meeting basic customer needs, because at the end of the day, there’s no better way to drive top line profitable growth. The second key element of the game plan is driving a relentless focus on day-to-day execution, improving the basic blocking and tackling across all elements of our business and looking for every opportunity we can to strip out complexity from our core business processes and to strip out non-value added activities.

The third, we have talked about is increasing our focus on cost management which is clearly always a key element of a well run business, but especially so in this difficult economy and as we continue to strip out costs and run as lean as we can, we remain foremost focused on improving customer satisfaction and making sure that we keep those two goals congruent.

The last is addressing our underperforming locations and as we’ve described, like any company we’ve got a spectrum of profitability across our locations and we continue to relentlessly focus on the bottom of that spectrum. So, I thought it was useful to just briefly recap the game plan and what I would now like to do is give you a couple more examples of how we are making that play out.

First, let’s talk about cost management. As you may recall, last quarter we announced a number of significant changes. We realigned our US field organization we closed regional offices, we reduced our corporate overhead across all levels of corporate, including the executive level and we made some other changes to some of our benefits and incentive programs and what I want to highlight is, those actions may appear as an event, but really tight cost management has increasingly become an ongoing way we are doing business. It just has to be a standard operating procedure for all of our managers in every corner of the company.

One example that I want to quantify of how that is playing out is here at corporate. Our corporate spending is down 14% since we put our new game plan in place. That’s comparing Q2 corporate spending to Q4 corporate spending from last year. In a period when our revenues were down 5%, so it is a good example of looking to make sure that our cost controls are outpacing the decline in revenue and that cost management is clearly becoming a way of life for all of us, not just a onetime event.

I would also like to give you some examples and talk a little more about our underperforming locations. Last quarter, we talked about some changes we’d made in some of our underperforming locations, a few divestitures. We highlighted one example that wasn’t the divestiture so you could see those kinds of non-divestiture related activities and while we choose to highlight those, we’re clearly focused on several others at the same time and what we would like to share with you today is the early results of that effort are very encouraging.

When you look at the group of businesses that we defined as needing targeted attention and focus, our operating income has improved $2 million on a quarterly run rate basis since we launched our new game plan. So, on an annualized basis across that group of businesses, that’s one point of operating margin improvement on our total P&L. So as I say, very encouraging early results, but clearly still early in the game. We’ve continued our activity in this area, and let me give you a couple of updates.

During the second quarter, as you read in our press release, we divested the majority of our North American cleanroom operation. In our effort to better focus our overall business we stepped back and we took a hard look at the cleanroom business and we concluded a couple of things. First, the vast majority of our customers don’t require cleanroom services and when you look at the types of customers that do require cleanroom services, you see a couple of things in those industries.

The industries continue to consolidate and they continue to move production offshore and the net of that lower volume has been much more competitive pricing, resulting in lower margins in that area of our business. So, when we step back and look at it and we clearly regard it as a non-core specialty business, we choose to divest it. It gives us a further opportunity to increase our focus on our core uniform market.

The revenue impact of that is something less than 2% of our total revenue. Another update I would like to give you. We are in the final stages of closing on the divestiture of another linen operation. As we have said several times recently, flat linen operations tend to be they’re not always, but they tend to be investment heavy in specialty equipment. They tend to be more labor intensive and they tend toward being a commodity product, all of which result in lower margin.

So we are making what we anticipate will be our last linen divestiture, which will really allow us to continue increasing our focus on our core uniform rental business and again, similar to the cleanroom on an annual basis, it is something less than 2% of our total revenue and I would also like to remind you it is a third quarter impact, but as it is in the final stages, we thought it was worth highlighting today.

One other important footnote to both of these transactions is as we move forward with these; we continue to maintain our core geographic presence for both our rental market and our direct sales capability, because that is what’s important to our broad customer base.

In a few minutes, Jeff will provide you a little more detail on both of those as well as take a step back to ensure everybody has got their arms around the net of all of the divestiture activity we have been talking about in the last couple of calls. Before I hand it off to Jeff however to take you through some of the financial details, I want to talk a little more about one other area. I want to talk about our top line revenue and the Q3 outlook.

I would say that, clearly, we are glad to see the sequential decline in our revenue continue to moderate; but equally clearly, we recognize the imperative of not just moderating it but turning it around to a sequential increase and we really hate to be on the this call talking about the next quarter as flattish from a revenue point of view, but candidly there is a lot of noise in our revenue numbers.

We saw higher than normal holiday impact which the way our quarter falls affects both Q2 and Q3. I just described some additional divestiture activity, which is on the heels of activity in the previous two quarters and as you might imagine, as we continue to reshape the company we’ve got a lot of other moving pieces and changes that we’re making. All of that in the face of a continuing difficult economy, so there is a lot of noise in our revenue numbers, but nonetheless, I know it is a question and I thought it was worth stepping back today to put our efforts in that area and a little bit of perspective.

We have been very clear about our new game plan. We have been very clear that it has four key elements which we have consistently described and as you might expect we got a tremendous amount of activity and focus across all four areas of the game plan. The challenge is by definition the results from that focus in activity are going to come faster in some areas than in others and frankly, that’s reflected in the examples that we’ve given you, as these calls updating you on our game plan have progressed.

So for example, when you take tough cost management actions like we have, you are going to see the results very quickly, almost by definition and when you take some of the other tough business actions we’ve taken, principally the divestitures and some other things we are doing to fix some of our core profit locations.

Again, you are going to see the results very quickly, but when you work aggressively on some of the fundamentals in the business in key areas such as sales and our service team and our marketing that drive the top line, it’s going to take a little longer for some of those changes in approach to take hold.

We have no doubt that they will and so when you hear us talk about the second element of our game plan, the real focus on day-to-day execution; it’s disproportionately in those kinds of areas that we are changing our execution game. So in short, I think there’s going to be some puts and takes on a quarterly basis, but we don’t have any question that we are taking the right day-to-day actions to turn this business around, regardless of which quarters they happen to fall in and the net of that is, about the trend line, we have no doubts.

So before I turn it over to Jeff, if I step back and summarize the quarter from my perspective, we showed continuing sequential progress on both revenue and earnings. Our game plan absolutely remains unchanged. It has been well received by the team. It’s increasingly embedded deep in the organization and there’s clearly a lot of moving parts, which will mean some ups and downs along the way, but six months into our new game plan we are as confident of the path we’re on as we have ever been.

Ask Jeff to take you through the financials that support that and then we’d be happy to take any questions you may have.

Jeff Wright

Thanks, Doug, and good morning everyone. This morning I will cover three areas in more detail. First, I will review our second quarter of financial performance. Next, I will provide more detail on our cost reduction initiatives and provide additional perspective on recent divestitures and then, finally, I will provide some directional insight for the fiscal 2010 third quarter.

So, first, the financial review. To start, I’ll provide an overview of our second quarter performance. For the quarter, revenue totaled $206.4 million compared to revenue of $241.8 million in the prior year, down 14.6%, lost customers from difficult economic conditions, lower customer employment levels, increased price competitiveness and a tough selling environment all pressured revenue.

The good news is that, on a sequential basis, our total revenue was down only about 1%. As expected, direct sale revenue grew from the first quarter and our rental revenue growth, while still negative, continued to stabilize. Sequential revenue was also impacted by divestiture activity, which was partially offset by a stronger Canadian dollar. For the second quarter, the rental organic growth rate was approximately negative 14% compared to the prior year.

Customer employment levels improved slightly for the third consecutive quarter, and our rental revenue decline has continued to moderate. On a sequential basis after adjusting for foreign currency translation and divestitures, rental revenue is down just 1.5% from the first quarter of 2010. This compares to a sequential decline in rental revenue of roughly 3% last quarter and about 5% in our fiscal 2009 fourth quarter. So, again, the decline in rental revenue has been moderating, which is encouraging.

Turning to direct sales, second quarter direct sale revenue was $15.0 million compared to $20.5 million in the prior year period. Direct sale volume continues to be impacted by weak overall economic conditions and the non-renewal of one large customer. On a sequential basis, direct sale revenue grew by almost 21% as a result of our annual outerwear promotion.

Now turning to earnings, second quarter earnings were $0.39 per diluted share and compared to earnings of $0.52 per diluted share in the prior year period. For the quarter, earnings include gains from divestiture activity and asset sales, which totaled $0.08 per diluted share. So adjusted earnings of $0.31 per diluted share benefited from savings from expense reduction activities, lower energy costs, a decrease in merchandise expense and a lower effective tax rate.

The lower than anticipated tax rate resulted from enactment of a provincial tax rate reduction in Canada and the adjustment of certain Canadian deferred tax liabilities. The lower tax rate benefited earnings by approximately $0.04 per diluted share. These benefits were offset by the reduction in fixed cost absorption due to lower revenue. As expected, we drove a solid sequential improvement in earnings per diluted share even when excluding the net gain from divestitures and a lower than anticipated tax rate.

Second quarter operating margin was 6.9% compared to 8.1% in the prior year period. When excluding net gains from divestitures, second quarter operating margin was 5.9%, up 60 basis points compared to the first quarter adjusted operating margin of 5.3%. The sequential improvement in adjusted operating margin resulted from a reduction in staffing levels, efficient utilization of merchandise, and the recent modification of certain benefit and incentive programs.

These operating margin improvements were partially offset by costs associated with a union decertification at one location and expenses related to divestiture activity. Despite the economic pressure to revenue and earnings, we continue to generate strong cash flow. For the quarter, cash flow from operations is $27.1 million and free cash flow was $23.9 million.

We expect to continue to generate solid cash flow for the balance of the fiscal year. We continued to utilize our strong cash flow to pay down debt and fund our quarterly dividend. Debt net of cash is now down $87.2 million as compared to the second quarter last year. As such, our financial stability and flexibility remains strong.

Now turning to a little bit more detail on cost reduction initiatives. As part of our new game plan, we have taken significant actions to lower our cost structure. On last quarter’s call, we highlighted a realignment of our U.S. field organization, the closing of several regional offices, the modification of certain benefit incentive programs, and significant staffing reductions at our corporate headquarters. We’re pleased to report that these actions are producing meaningful savings.

Additionally, we are continuing to strip out overhead costs and are driving significant savings in fixed cost areas such as insurance, professional services, and property related expenses, to name a few. As such, our adjusted selling and administrative expense in the second quarter is down over 7% compared to just six months ago. We will continue to drive costs out of the business to run lean while also continuing to move resources and decisions closer to the customer to support our redoubled focus on customer service.

Now let me give you a little bit more detail on recent divestiture activity. In addition to increasing our cost management focus, we’re also addressing underperforming businesses as part of our new game plan. As you may recall, previously we divested one small unprofitable operation, divested two non-core flat linen operations and made several operating changes at a major metro market location.

As highlighted earlier, we’re pleased to report that for the second straight quarter, our bottom performing locations improved operating income by approximately $1 million sequentially. So as Doug mentioned, our quarterly operating income run rate for these businesses has improved by $2 million since implementing our new game plan, which equates to an $8 million annual run rate or about a one point improvement in the total company operating margin.

While very early yet, we continue to execute against location specific game plans to drive increasing operating margins. For example, during the quarter we divested the majority of our North American cleanroom operation. This business had been experiencing declines in volume and intensified pricing pressure.

As a result this business had lower than average operating margins. This divestiture will allow us to focus all of our energy on serving our customers’ core, uniform and facility service business needs. This non-core specialty business accounted for a bit less than 2% of our total revenue.

In addition, we’re in the final stages of divesting another linen operation. This divestiture did not impact second quarter revenue as we anticipated closing in the third quarter. This business served primarily healthcare and hospitality companies and generated quarterly revenue, again of less than 2% of our total revenue. As mentioned earlier, flat linen businesses require specialty equipment and higher levels of manual labor. This coupled with linen being viewed more as a commodity product, leads to lower margins than we generate in our core uniform business.

With the anticipated third quarter closing of this final linen operation, we will have completed five divestitures in the past six months. These operations were not part of our core uniform and facility services business. In total, the five divested operations accounted for approximately $30 million to $35 million in annual revenue.

While we can’t guarantee that there won’t be further divestitures at some point in the future, we have completed the divestitures that were on our near term radar. These actions were part of addressing a number of underperforming and lower margin businesses. We will continue to take decisive actions to address underperforming locations and earn our right to grow.

Now moving to the future, as we disclosed previously, we will not be providing specific revenue and earnings guidance for the foreseeable future, but as we’ve done over the last couple of quarters, we will provide some directional input to help the investment community assess our near term performance.

As stated in our press release this morning, we expect third quarter revenue to be generally consistent with second quarter after adjusting for divestitures. Divestitures will decrease revenues by approximately $4.5 million, when comparing second quarter to the third quarter. While we’re encouraged that we have seen a continued moderation in the decline of our rental revenue, economic and employment conditions remain difficult and have not yet reached bottom.

In addition, as Doug described, we’re making a number of changes to processes and programs that will take a little longer to take a hold. From a profitability standpoint, we expect third quarter operating margin to also be generally consistent with second quarter after adjusting for increased expenses associated with the annual reset of payroll taxes, and for any gains or losses associated with third quarter divestiture activity.

Payroll taxes historically have impacted operating margin by about one full margin point when comparing the second quarter to the third quarter. In addition, we expect our third quarter effective tax rate to be higher than the second quarter and to be a more normalized rate of around 40%.

As Doug described, our new game plan is moving us forward and providing improved results. We will continue to make significant changes to reshape G&K and improve our performance. With that said, we are confident we are moving in the right direction and look forward to reporting our progress in the quarters ahead.

That concludes our prepared remarks. At this time, we will turn it back to the operator and we’d be glad to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from John Healy - North Coast Research.

John Healy - North Coast Research

You guys keep talking about the phrase earning your right to grow and I was hoping I could understand that a little bit better. Doug, what sort of margin profile as a company do you think you need to get to before you’ve earned your right to grow? Without the economy getting any better from here, what level of margins can you get to by addressing the cost structure and continuing to execute on your plan?

Doug Milroy

John, earning your right to grow is a phrase I picked up a long time ago from a colleague and it has just kind of stuck in my playbook ever since. I wouldn’t peg it to a specific margin. So there’s probably no point at which I’m going to stop using that comment is what I’m trying to say. So I wouldn’t peg it to a particular margin.

It’s more about a philosophy that says too often in business line managers say, “If I just could dump some more revenue in here, then I’ll make the business profitable.” I have a philosophy and it’s the one we’re driving deep into the company is, no. You have to figure out where you’re at today and how to make that profitable. That is earning your right to grow.

Then we can worry about where the profitable growth will come from. So you clearly have to walk and chew gum. You’ve got to be focused on growing your top line, but there’s an order to things and we’re trying to focus foremost on expanding the operating margin.

John Healy - North Coast Research

You talked a little bit about the competitive environment or the pricing environment being pretty tough out there. I was hoping you could describe more the environment rather than the absolute level of pricing decline. Where the pricing compression is coming from and your thoughts on can the pricing in this business get back to what it was historically in the future?

Is this a business that you believe you can get price increases on contracts for the long term or is it going to be a business that you might get a few years of price increases, but when it resets you kind of go back to your one pricing? I was hoping to understand your philosophy on that.

Doug Milroy

I would say that pricing is competitive in every business I’ve ever been, I thought pricing was competitive. So that would be the first point. The second point would be funny how that pricing competitiveness or intensity is always exacerbated during a tough economy as everybody works to hang on to what they have and continue to grow new business. So you continue to see that.

The way that you beat that back is to shift the whole focus to value. “What are we doing for our customers to create value for them and how they run their operation?” Because if you create value for your customer, then the only remaining question is “How that value gets divided up between you and your customer?” If you’re not creating it in the first place, there’s no division of the spoils.

More specifically trying to answer your question about “What we see on a go forward basis? The contracts that we enter into continue to have price escalators in them. We have nothing that would indicate us in the market that that shouldn’t continue because, again it’s about being able to demonstrate to your customer on an ongoing basis that you’re not just providing value, but increasing value as you get working with them more and more closely and what we do affects their operation. So we’re doing it today, John and I don’t see any reason on the horizon why it would change on a go forward basis.

John Healy - North Coast Research

Then just last question. You mentioned that the seasonality coming out of the holiday timeframe has been a little bit more than you thought. When you look at kind of how January shook out in terms of that seasonal impact, can you give us a little bit more color there and maybe try to understand how much more intense it was this year?

Jeff Wright

I wish we could give you some real strong evidence of the holiday impact. Unfortunately, I think our systems aren’t able to generate that and accumulate it kind of companywide, but we would tell you we do have a fair amount of anecdotal information and conversations with our field personnel that say that typical holiday shutdown periods were longer and more extended this year, that companies continue to look for ways, our customers continue to look for ways to reduce their costs and keep their businesses healthy and where they maybe had a one week shutdowns in the past, they had a two week shutdown this year and those types of examples.

The holidays for us, we’ve got a quarter end here right at the end of December. So kind of the call it the Christmas holiday season has impacted Q2 and then the New Year’s will impact Q3. So we’ve got a little bit in both quarters. We’re obviously the timing of ours is a little bit different compared to our competition who most recently reported their last quarter, but as of the end of November. So they haven’t yet picked up the full holiday impact, but we would tell you that anecdotally a little heavier than normal, based on conversations with our field personnel.

John Healy - North Coast Research

Just a follow-up on that, Jeff, you’ve seen some of that seasonality kind of work itself out by now, right? So it’s not a sign that maybe the customer base is encountering another step down, it was just really because of the seasonality.

Jeff Wright

If I understand your question right, again, we incurred some of that holiday impact in Q2. We will incur some in Q3 and again, I just think it’s a matter of customers that are continuing to run their businesses as tight as they can.


Your next question comes from Nate Brochmann - William Blair.

Nate Brochmann - William Blair

Just wanted to kind of get a sense for where we are in the game plan in terms of the four points, clearly on the divestitures. It feels that at least on what’s on the horizon is kind of over, but in terms of what inning we are in a lot of the other things that you have up your sleeve, do you think we’re about a third of the way through what you’ve identified so far in terms of additional savings opportunities or about halfway through?

Also just maybe from a 30,000 foot level like what the general run rate is of all those savings? You pointed to a couple of areas specifically, but maybe in total if you could give us a little sense of that?

Doug Milroy

You know as you asked the question and you threw the phrase out, what inning are you in? I landed on the second. So we’re using an analogy, so I’m not sure there’s any science to it, but we are definitely in the early stages of the game. We thought it was useful today to try and draw a line under the divestiture conversation.

As Jeff said, nobody can guarantee there’ll never be future changes, but if you recall, we’ve talked in other discussions about the bottom end of our spectrum, from the performance point of view, it will always be a focus of ours. So we’ve taken some very significant measures in terms of divestitures, but continuing to focus in that area will always be a focus of ours.

You, by definition, will always have a bottom quartile we just want to keep moving it up. So that will be an ongoing part. Cost management, as I just described is increasingly becoming a way of life for everybody in the company that will be an ongoing part. If you think about better day-to-day execution, the second part of the game plan that’s about continuous improvement.

That’s making sure, we understand what our core business processes are and we’re always focused on improving them. How do we measure them, how we monitor them and how do we drive improvements in them on a continuous basis. Then the last part is, never going to go away. The first part of the game plan is about customer focus and the profitable growth that comes from that.

So in some respects, it feels like the early stages of getting that game plan out there and the team working with that and so, we’re not seeing all of the points on the board yet that we’d like to and that’s why I jump on, it’s the second inning. In other respects, I think we’ll be talking about our game plan for a long time, because I think we’ve wrapped our arms around it as the fundamentals for our business and it will continue to drive continuous improvement in our business.

Jeff Wright

Maybe if I could respond to, I think what was the second part of your question, which is kind of getting at the run rate of margin, and how much you achieved and so forth have and I guess I would say, agree with Doug that were early into the game plan here, but we as we tried to articulate in addressing our underperforming locations, we’ve added rough numbers about a point of operating margin improvement for the whole company as a result of those actions.

Then as a result of the actions on kind of the overhead piece of it, running lean and scrubbing our cost structure, there again we probably added somewhere in the range of about a point. So there’s a couple of points of operating margin improvement and your next question might be, ‘let’s see you added 60 basis points this quarter and 60 basis points last quarter, but that’s only 120 basis points.

How does that compare to the two points that you’ve described? I think, I’d just reiterate to you that, as we make these changes and we’ve referred to puts and takes, but there are expenses that go with this. We’re making divestitures, we’re making major changes to a number of our locations, etc., and so there are costs that kind of offset that.

Secondly, of course we continued to have, it’s a moderating reduction, but a little bit of revenue decline, which impacts our overall profitability. So a couple of things that offset it, but I think you can clearly see the impacts hitting our P&L and then the last thing I would say is, it’s very early on. So these are some early wins, but more to come.

Nate Brochmann - William Blair

Then second question, kind of talking about the top line and it’s kind of in conjunction with that, in terms of talking about that refocused customer service, have you seen somewhat of a shift in either your market share gains or in terms of some areas within your customer base that you could point to, in terms of that starting to take effect?

Doug Milroy

No. I would say that it’s too early in terms of the shifts in market share or particular segments. Some of the things will become increasingly focused on a go forward basis. I think it’s too early to see that play out in broad shifts and share gains.


Your next question comes from Justin Hauck [Inaudible].

Justin Hauck – Unidentified Company

Had another quick question on the margins, just with the merchandised cost, it sounds like you’re still seeing some benefit from that. Just wondering, are we kind of at the peak at this point, where once the economy starts to pick up and we’re adding some employees, that benefit is going to go away, or do you think over the next couple of quarters you can still see some benefit on the merchandise cost amortization?

Jeff Wright

We viewed that there’s a fair amount of upside left with our merchandise expense. You know, a lot of merchandise expenses are managing that asset that you have on the books. We have obviously, a significant amount of uniforms and mats and towels that are in service, of course, we maintain significant stock rooms of used merchandise that we can put back to work.

One of the ways that you can really drive benefit for your customers and for us is to fully utilize that used stock room, and making sure that you’re putting that the service for your customers. and one of the opportunities in front of us is as employment let’s knock on wood, employment does start to turn around here, that we can put that used stock to work and bring in that incremental revenue, but use an asset that’s already on the books versus putting a new asset in place. So we think there’s a good opportunity in merchandise and we’ve got the team focused on it.

Justin Hauck – Unidentified Company

Are you able to quantify kind of what your utilization rates are looking like right now versus six months ago when you put the new plan in place?

Jeff Wright

You know, that’s probably a level of detail that we haven’t shared in the past. I can just tell you that, we’ve got reporting and visibility throughout the company down to the lowest levels in the organization on properly managing what we call replacements, but properly managing the amount of uniforms that we’re putting into place at our customers.

Justin Hauck – Unidentified Company

Just last question on a margin front, energy costs. I know they were basically flattish last quarter, maybe ticked up a little bit, but as they’ve moved upward, was that kind of a net hit to you this quarter sequentially? Maybe as a percentage of sales, what energy was?

Jeff Wright

Yes and let me just pull out the numbers here. As you asked the question, I was ready to respond unless you know that energy costs were a positive on a year-over-year basis, comparing Q2 of last year to Q2 of this year. If you look sequentially, they were about flat maybe just a tick up from Q1 to Q2 but, again, positive on a Q2 over Q2 basis.

Then of course, I think we all know what the forward curves look like and the direction, but I think we see both gasoline and diesel that we use in our delivery fleet and natural gas that’s used in the plant, that both of those appear to be trending upward and so some of that positive variance that we had this quarter, year-over-year, is going to diminish here as we move into Q3.

Justin Hauck – Unidentified Company

Final question just on headcount reductions, how does the sales force look at this point? I mean are we still is that intact where that the headcount has really just been on the corporate side? Or is sales force, have you actually cut some at this point?

Doug Milroy

The sales force is actually rolling up to a lower number for now and I want to talk about that a little bit. I’m glad the question came up. It’s one of the changes we’re trying to make and how we’re running the business. I think that there’s been way too much historical focus on one thing headcount.

If you think about it, the goal is, obviously, we’re trying to bring revenue in and revenue is the multiplicant of a headcount time’s productivity. We haven’t focused enough on the productivity number and so, with our sales team, we’ve made kind of two broad changes. One is to focus more and more of our energy on productivity of the individual seller and that’s things like enhancing their training.

We talk about day-to-day execution, its things like reducing the complexity they have to deal with on a day-to-day basis, stripping out non-value-added activities that maybe the sales force was spending their time on previously. We’ve talked in the past, if you go back a couple of years ago, we talked about making investments in sales force automation. As we sit today, we are not convinced we got all the utility from that sales force automation that we could and that there’s some still there to get.

So let’s focus on that, so that’s kind of the broad just some examples in the broad bucket of productivity. Then when you talk about headcount, it’s more not the aggregate discussion, but having the detailed discussion with our District Sales Managers with the people who are closest to it. You’ve heard a recurring theme of moving decisions and resources closer to the field.

So it’s having those detailed discussions with our District Sales Managers as they work to evaluate their needs in a particular location, their ability to assimilate and train new teams, and so on and so those two shifts have resulted in the net of all that rolls up to a lower sales number than we were carrying, say, six months ago, but the focus isn’t on just headcount, it’s on bringing total revenue in the door.


Your final question comes from Mike Hamilton - RBC Capital Markets.

Mike Hamilton - RBC Capital Markets

Coming back around to pricing, could you give assessment of where you think we are in the pricing cycle as you look at things?

Jeff Wright

That’s probably a tough question. I guess I would as probably the only thing I could compare it to would be a previous downturn. You know the economy turned down as we all know back in the kind of 2002, 2003 timeframe. Pricing got pretty competitive in that down cycle and then seemed to rebound to kind of normal levels of price competitiveness after that.

I think this cycle, it feels like a little bit of the same although this downturn has been a tougher downturn overall. When we look at our net price changes that are happening with our customer base, clearly late winter, early spring, early summer timeframe was a pretty tough environment, pretty competitive environment and now as we’ve moved into fall and winter here, still competitive but a little less so than what it was spring and summer.

So it appears to be abating a bit, although again I would reiterate it’s still competitive, not irrational but still very competitive, as we’re operating in this tough economy.

Mike Hamilton - RBC Capital Markets

Some of that when Jeff talks about abating a little bit, some of that curve obviously comes back to what you think is going to happen with the economy. Because, if you go back to the earlier comments I made about pricing, pricing, to some degree, is always competitive. It’s exacerbated by a difficult economy.

Doug Milroy

So if that turns around and you know that our particular challenge within that is not just that the economy turns around, but that people start going back to work. So, having a clear outlook into the question you asked is partly linked to that where none of us have a very clear crystal ball just now.

Mike Hamilton - RBC Capital Markets

Jeff, could you give FX impact on top and bottom line on the quarter?

Jeff Wright

Sure. I’ve got the top line in front of me. I know that if you compared Q2 revenue and compare it to the prior year Q2, it lifted revenue a little over $4 million. Actually if you compare I’ll give you another number.

If you compare Q2 to Q1, it lifted revenue by a bit over $1 million and that actually offset in terms of comparison to our expectation offset the impact from the added divestitures that we made in the quarter, but so about one as my calculation is, a $1.4 million impact Q1 to Q2 and about a $4.2 million impact Q2 over Q2. Again I don’t have the bottom line, but if you run it based on our margins and what not, you could probably get to an estimated bottom line.

Mike Hamilton - RBC Capital Markets

Any insights you care to give on CapEx for the remainder of the year?

Jeff Wright

I guess the only insight I would share with you is I wouldn’t think that there would be a real deviation from what the trend line has been. CapEx, we are still targeting probably in the low $20 million range, between $20 million and $25 million would be a good target for the year so the level of spending might be up just a little bit in Q3 and Q4 compared to Q2 levels, but not a lot. I think we are continuing to manage capital spending well and focused of course in this downturn economy, focus on utilizing the assets we have.

Mike Hamilton - RBC Capital Markets

Then just a couple of expense related questions. Is there anything worth noting either on hedges, on healthcare expense or on bad debt flowing in the quarter?

Jeff Wright

Of the ones that you mentioned there, the only one I would say is that it is partly due to our overall headcount is down, but we’ve seen some actually fairly good experience with both healthcare and workers comp and some of those types of things. We’ve had a pretty intensive focus on improving safety and focusing on the health of our employees and those appear to be taking hold. So I would say that those are showing some positive signs. I think on the other items you mentioned, it would not be noteworthy.

Mike Hamilton - RBC Capital Markets

I take it that your Irish cleanroom facility is operating as you expect and no changes in your thinking there?

Jeff Wright

The Ireland cleanroom facility is operating as expected. It’s quite a small operation and obviously we’ve chosen to divest the US operations and we are in the process of evaluating our Ireland cleanroom.


At this time, sir, there are no further audio questions.

Doug Milroy

Okay. Thank you very much, operator. Okay, well, if there are no further questions we will just wrap up. First of all, again, thank you for calling in. We appreciate the interest in our company. We are clearly well on our way with our new game plan. It continues to move our company forward and I hope you see that through the examples we take you through. It gives us real confidence on a go forward basis and we look forward to updating you on that in April. Thank you everyone.


Thank you, sir. This concludes today’s conference. You may now disconnect.

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