Cintas (CTAS) Management on Q4 2016 Results - Earnings Call Transcript

| About: Cintas Corporation (CTAS)

Cintas Corporation (NASDAQ:CTAS)

Q4 2016 Results Earnings Conference Call

July 19, 2016, 05:00 PM ET

Executives

Mike Hansen - Vice President of Finance and Chief Financial Officer

Paul Adler - Vice President and Treasurer

Analysts

Gary Bisbee - RBC Capital Markets

Nate Brochmann - William Blair

Sara Gubins - Bank of America Merrill Lynch

Jeff Goldstein - Morgan Stanley

Andrew Wittmann - R.W. Baird

Joe Box - KeyBanc

Scott Schneeberger - Oppenheimer

Adrian Paz - Piper Jaffray

Andrew Steinerman - JPMorgan

Dan Dolev - Nomura

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. Mike Hansen, Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

Mike Hansen

Good evening and thank you for joining us. With me is Paul Adler, Cintas Vice President and Treasurer. We will discuss our fourth quarter results for fiscal 2016. After our commentary, we will be happy to answer any questions.

The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor from civil litigation for forward-looking statements. This conference call contains forward-looking statements that reflect the company's current views as to future events and financial performance. These forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those we may discuss. I refer you to the discussion on these points contained in our most recent filings with the SEC.

We are pleased to report fourth quarter revenue of $1.271 billion, an increase of 11.3% from the prior year fourth quarter. Organic revenue growth, which adjusts for the impact of acquisitions, foreign currency exchange rate fluctuations, and workday differences, was 6.7%.

Fourth quarter operating income was $203 million, an increase of 14.2% over last year's fourth quarter. Operating margin improved to 16% of revenue, compared to an operating margin of 15.6% in the prior fiscal year. The Uniform Rental and Facilities Services segment led the way with an operating margin of 17.7%.

Net income from continuing operations for the fourth quarter of fiscal 2016 was $118 million compared to $101 million in the prior year, an increase of 17.3%. Net income from continuing operations as a percent of revenue improved to 9.3% from 8.8% of revenue in last fiscal year's fourth quarter.

Earnings per diluted share or EPS, from continuing operations for the fourth quarter were $1.08 compared to $0.86 for the fourth quarter of last year. Fourth quarter EPS from continuing operations increased 25.6% compared to the prior year period.

As our CEO Scott Farmer stated in today's earnings release, these achievements are the results of our employees, whom we call partners in being ready for our customers. I'd like to take this opportunity to thank our partners for continuing to generate industry leading results.

Our fourth quarter results were a strong finish to an excellent fiscal year, one in which we achieved record revenue and record EPS. We have a diverse customer base with about 70% of our revenue coming from customers and services providing areas of the economy. This has been made possible by our wide range of products and services.

As a result of these and other assets, we have grown significantly in excess of US GDP and jobs each year since the Great Recession, and we are the clear leader in our industry, and in more ways than one, including size, growth rates, profit margins, quality, service and innovation.

In addition to the success on the top line, we have delivered it on the bottom line. As Scott Farmer stated in today's press release, Cintas has increased EPS by double-digits in six consecutive years. Our research indicates that this feat has been accomplished by less than 5% of S&P 500 companies.

Our cash flow and scale allow us to invest in numerous ways. In fiscal 2016, those investments included CapEx to both maintain and grow the business, and strategic investments, like our SAP project, and new Ready for the Workday branding campaign. We made acquisitions in our Rental, First Aid and Fire businesses and we have the capacity to do more.

This past year, we paid our regular dividend and it was an increase of 23.5% over the prior-year's dividend. Since we went public in 1983, we've increased the annual dividend every year. Finally, in fiscal 2016, we repurchased shares under our buyback program at an aggregate cost of $759 million, including $276 million in our fourth quarter.

Looking ahead to fiscal 2017, we expect revenue to be in the range of $5.150 billion to $5.225 billion, and EPS from continuing operations to be in the range of $4.35 to $4.45. This guidance does not include any potential deterioration in the US economy or future share buybacks. It does include our expectations for our continued SAP system implementation, and the impact of one less workday in fiscal 2017, compared to 2016.

We estimate that this one less workday will negatively impact fiscal 2017 total revenue growth by about 40 to 50 basis points and operating income margin by approximately 10 to 15 basis points in comparison to fiscal 2016.

I'll now turn the call over to Paul for additional information.

Paul Adler

Thank you, Mike. First, please note that there were 66 workdays in this year's fourth quarter compared to only 65 in last year's fourth quarter. We estimate that this additional day benefited the quarter's operating income margin by 40 to 50 basis points.

As Mike stated, total revenue increased organically by 6.7% in the fourth quarter. This solid growth rate was driven largely by new business wins, penetration of existing customers with more products and services, and strong customer retention.

About 60% of new business wins continue to come from no-programmers, or customers that have never had a rental program. We are providing no-programmers in healthcare with scrub rental, those in construction and trades with Carhartt-branded workwear, and no-programmers and customer-facing positions like retail, theme parks and transportation, with performance polos and cargo pants.

Our broad range of innovative and proprietary products and services enable us to do more for the customer, including uniform and mat rental, hygiene, first aid supplies, CPR and other training, and fire extinguisher testing and recharging, to name a few. And the more we do for the customer, the more they appreciate our quality and service, and the less likely they are to leave us.

Total company gross margin was 43.6% for the fourth quarter of this year, compared to 42.6% last year. Total company energy-related expenses, including gas, diesel and natural gas for this year's fourth quarter were 1.8% of revenue, about 40 basis points lower than last year's fourth quarter.

Note, however, that we continued to see the impact of headcount reductions in the oil, gas and coal industries. We estimate that the resulting decrease in revenue from customers in these industries lowered our organic growth rate by about 100 basis points in the fourth quarter and reduced our operating margin by about 50 basis points.

So, the low fuel prices were not enough to offset the negative impact from our energy customers, and the net impact from energy was a headwind of about 10 basis points.

We have two reportable operating segments, Uniform Rental and Facility Services, and First Aid and Safety Services. The remainder of our business is included in All Other. All Other consists primarily of Fire Protection Services and our Direct Sale business. First Aid and Safety Services and All Other are combined and presented as Other Services on the income statement.

Uniform Rental and Facility Services operating segment included the rental and servicing of uniforms, mats and towels, and the provision of restroom supplies and other facility products and services. The segment also includes the sale of items from our catalogs to our customers on route.

Uniform Rental and Facility Services revenue was $965 million, an increase of 8.3% compared to last year's fourth quarter. Excluding the impact of foreign currency exchange rate changes, workday differences and acquisitions, organic growth was 6.3%.

At this time of the year, we provide revenue mix for this segment. Due to the fact that we changed our segments this fiscal year, I will provide the prior year data for comparability. The revenue mix for the segment for the fourth quarter of fiscal 2016 and 2015 was as follows.

Uniform Rental accounted for approximately 50% of total revenue compared to 51% last year. Dust Control, comprised mainly of entrance mats, accounted for 18% in both years. Hygiene and Other Services, including Restroom Supply, Cleaning Services and Chemical Services, was 14% of total revenue versus 13% last year.

Shop towels were unchanged from prior year at 5% of revenue. Linen and Other, which is mainly non-person-specific garments such as aprons and butcher coats was 9% compared to 8% last year, and Catalog Sales were 4% this year versus 5% last year.

Our Uniform Rental and Facility Services segment gross margin was 44.3% for the fourth quarter, an increase of 150 basis points from 42.8% in last year's fourth quarter. We estimate that the extra workday in this year's fourth quarter compared to last year benefited operating margin about 40 to 50 basis points, the majority of which falls within gross margin.

Energy related costs were 50 basis points lower than in last year's fourth quarter. However, job losses in oil, gas and coal negatively impacted this segment's current year fourth-quarter operating margin by about 50 basis points.

So, on a net basis, the low fuel prices did not benefit our Uniform Rental and Facility Services operating margin because they were offset by the headcount reductions impacting our oil, gas and coal customers.

Our First Aid and Safety Services operating segment includes revenue from the sale and servicing of First Aid products, Safety Products, and Training. This segment's revenue for the fourth quarter was $123 million, which was 45% higher than last year's fourth quarter. Total growth benefited from the ZEE Medical acquisition. On an organic basis, growth for this segment was 6.9%.

This segment's gross margin was 42.9% in the fourth quarter compared to 46.8% in the prior year period. Operating income margin was 10.9% compared to 15.2% in last year's fourth quarter. We did see a 30 basis point sequential improvement in operating margin.

The reduction in First Aid organic growth rate and margins is wholly attributable to the impact of the acquired ZEE Medical business. Recall that ZEE was about one-third the size of our existing First Aid business, a significant acquisition to this operating segment. We continue to incur the typical conversion costs, which impact margin from the short term.

The assimilation of the business, including route consolidation, is still in process, as expected. In fact, the fourth quarter saw the largest number of ZEE locations being integrated. All of these efforts have a short term impact to growth rates and margins, as is common in an acquisition of this relative magnitude. The completion of the integration will be followed by the realization in full of the synergies. We are on track and continue to be pleased with this acquisition.

Regarding selling, and general and administrative expenses, total company SG&A was 27.6% as a percentage of fourth quarter revenue compared to a total company SG&A in last year's fourth quarter of 27.0%.

Medical expenses as a percentage of revenue were 20 basis points higher in this year's fourth quarter. Also note that our new national branding campaign impacted SG&A by about 35 basis points.

On June 1st, $250 million of debt, with a coupon of 2.85%, matured. We refinanced this debt in the form of commercial paper. By staying short in commercial paper, paying about 70 basis points, we were able to reduce interest expense in fiscal 2017 by about $5 million, and avoid a headwind that would result from financing with long-term debt.

Our effective tax rate on continuing operations for the fourth quarter was 37.1% compared to 37.7% for last year's fourth quarter. The effective tax rate can fluctuate from quarter-to-quarter based on tax reserve builds and releases relating to specific discrete items. We expect the effective tax rate for fiscal 2017 to be about 36.7%. That's up slightly from fiscal 2016's 36.4%.

Our cash and marketable securities were $210 million as of May 31st, a decrease of $177 million from the balances of February 29th. Uses of cash in the quarter included $278 million for repurchases of Cintas common stock and $57 million to pay some of the taxes due on the gains related to the sale of our Shred-it investment.

Regarding the sale of the Shred-it investment, please note that the impacts are accounted for throughout the cash flow statement. The proceeds from the sale of $581 million are recorded as cash provided by investing activities, while the taxes paid on the gain from the sale are recorded as cash used in operating activities.

This accounting, while proper per Generally Accepted Accounting Principles has the effect of understating cash provided by operating activities and free cash flow if one does not remember that the taxes paid relate to a non-recurring transaction in which the benefits in the form of cash proceeds are recorded in another section of the cash flow statement.

So if we eliminate the impact of the sale of the Shred-it investment from the cash flow statement, cash flow provided by operating activities would be $695 million for fiscal 2016 versus $580 million the prior year, an increase of 19.8%.

Capital expenditures for the fourth quarter were about $68 million. Our CapEx by reportable operating segment was as follows, $56 million in Uniform Rental and Facility Services, $9 million in First Aid and Safety, and $3 million in All Other.

We expect CapEx for fiscal 2017 to be in the range of $280 million to $320 million. This range includes about $40 million of CapEx related to our SAP implementation.

Regarding SAP, as we disclosed last quarter, we expect to begin depreciating the project around December 2016. Our fiscal year 2017 will include about a half a year of depreciation. It will also include about half a year of system maintenance costs. The conversion of our hundreds of operations to SAP will occur during fiscal 2017 and extend through fiscal 2018.

Training costs, which are expensed when incurred as opposed to amortized over time, will exist in both fiscal 2017 and 2018. As is customary in such a conversion, we expect to have other additional costs in 2017 and 2018 as a result of inefficiencies until the old system is completely off-line.

We estimate that the investment in SAP will result in $30 million to $35 million of expense in fiscal 2017 and $45 million to $50 million of expense in fiscal 2018. The estimated fiscal 2017 expenses are included in our 2017 guidance.

We will begin to receive some cost structure benefits in fiscal 2019, but will likely see the power of the system beginning in fiscal 2020 once all operations have had some experience in running it.

That concludes our prepared remarks. We are happy to answer your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We'll take our first question from Manav Patnaik with Barclays.

Unidentified Analyst

Hi. This is actually Greg calling on for Manav. First off, I was just hoping you could help us bridge to your 2017 revenues between what you would consider organic growth and the FX or M&A impact?

And then maybe more specifically, you can talk about how you're thinking about organic growth in 2017 and how it compares to the - I guess, nearly 7% you delivered in 2016?

Mike Hansen

Greg, we don't typically give organic growth because lots of things can happen throughout the year. But I - you can probably see from our guidance where the revenue range is 5% to 6.5%. That's pretty much in line with what we gave in terms of initial guidance last year.

Keep in mind that, as I mentioned, we'll get a negative impact of 40 to 50 basis points because of the one less workday. And so I would say that we're not expecting too many changes this year, but we don't give specific organic growth numbers.

Unidentified Analyst

Okay. Fair enough. And then maybe on the energy side, it sounded like the negative net add stops were a little worse than you had expected in the fourth quarter. Maybe you can talk about the moving pieces and how you're thinking about that in 2017 between cost saves and potential further pressure, if we are in a lower for longer oil environment?

Paul Adler

Yes, Greg, it's Paul. Add stops were - they were negative this quarter, but they typically are. There are some seasonal impacts that impact us in the fourth quarter. For example, we have jackets coming off from the winter and being returned to the stock rooms. We have mats that are extra mats that some of the customers were snow and slush, and those are returned as well.

So typically, add stops are negative in the fourth quarter, and they are for us this fourth quarter. And then to your point, they are a little more so than typical, because we still are feeling the effects of headcount reductions in our energy customers.

In terms of next fiscal year, we can tell you that we still expect to have some headwinds from oil, gas and coal customers. We would expect the headwind to revenue in fiscal '17 to be about 60 basis points, and that's built into our guidance. So that's the top-line impact. On the bottom line, we would expect that to be a headwind then of about 30 basis points of operating margin.

The other impact that we believe we will have is just in the fuel costs. Whereas we had a benefit in fiscal '16, we're modeling that the fuel will be a headwind to our cost structure to maybe about 30 basis points.

Unidentified Analyst

A headwind to - on the cost side, higher fuel costs?

Paul Adler

Yes.

Unidentified Analyst

Okay.

Paul Adler

On fiscal '16, on a net benefit - or a net basis rather, in fiscal '16, considering the benefit of fuel and the cost structure and then the negative impact of the headcount reductions, reducing revenue and operating margin, we had like a 10 basis point improvement for fiscal '16. Whereas in fiscal '17, we are expecting it to be more of a 60 basis points headwind. So quite a significant change.

Unidentified Analyst

Okay. That's helpful. Thank you.

Operator

We'll take our next question from Gary Bisbee with RBC Capital Markets.

Gary Bisbee

Hey, guys. Good afternoon.

Mike Hansen

Hi, Gary.

Gary Bisbee

I thought it was an interesting statistic you gave, if I heard it right, that 70% of your revenue you think is from services industry end markets or customers. And can you just help us frame that, I mean, how - what would that have looked like five years ago? Has that been a pretty substantial shift over time or has it been more moderate?

Mike Hansen

I would say in the last five years, probably not too substantial. But over the last, let's call it 15 years, probably much more - and probably even more inverse of that. You know, as jobs over the last couple decades have been off-shored, we have certainly been forced to look for other ways of creating revenue in terms of the uniforms, and that, we've been very successful in the service providing areas.

And so, I would say it's different from certainly 15 years ago. It's probably not too different from five years ago. But I would say that it continues - we continue to perform well in those areas.

A couple of the different pieces that we would see as better today than maybe five years ago even, and certainly 15, would be healthcare, which, 15 years ago, we probably had a very, very small presence and food service.

And in both of those, we've been able to come up with creative solutions, innovative solutions, to get more of an impact in those verticals, and that certainly has helped us.

Gary Bisbee

And when we think about that, is that both a uniform rental story, and then also just penetration of a lot of the other stuff that has broader appeal or is it more the latter than the former?

Mike Hansen

No, that's all of our businesses. And when you think about the Rental segment by itself, there's not a lot of difference in terms of the vertical splits between Uniform Rental and Facility Services. We are providing many of those products to the same customers, and so not a lot of difference there.

Gary Bisbee

Okay. Great. And then if I could just ask one more. Can you give us any more color on how the branding campaign is working? I think we saw - we are seeing commercials, and seen them on the Internet and a few other things.

But what has that done? Is that just awareness or are you actually seeing this help you closing the business? Thank you.

Mike Hansen

Well, the branding campaign has continued, and we certainly - our Cintas partners, our employees are very energized and excited about it. And so it's had a positive impact on us certainly from an energy and excited standpoint.

But we're too early to begin to measure the impact of it. I think I mentioned last quarter that it would probably be more like the second half of fiscal '17 before we would start to really be able to measure any kind of impact.

Keeping in mind, it is a brand awareness campaign. So it is trying to make sure that our customers and our prospects understand and know all of the different things that we can provide to them, all of the different products and services. And we are not specifically targeting any one of them right now.

So, again, we're excited about it. It's going well. It's been - the feedback that we get anecdotally has been very good. But I don't expect to be able to give any measurements on it until the back half of fiscal '17.

Gary Bisbee

Sounds good. Thank you.

Operator

We'll take our next question from Nate Brochmann with William Blair.

Nate Brochmann

Hi. Good evening, gentlemen.

Mike Hansen

Hi, Nate.

Paul Adler

Hi, Nate.

Nate Brochmann

So just playing off of Gary's question there a little bit, and I think that's one thing that you guys have really done a great job of in terms of maintaining the sales momentum in somewhat of an underlying sluggish job growth environment.

Could you talk a little bit about, as you go back 15 years ago till today, in terms of being able to change the customer buying behavior to kind of except maybe those new rental uniforms that you have going into those newer industries for you?

And then, second, how much longer is that tail in terms of opportunity, given the fact that it's been only in the last, you know, call it, five or seven years that we've really made some real inroads there?

Mike Hansen

Well, I think the - from a customer perspective, I think it begins with innovative products. We can't get service industries to just simply change with what we might call legacy uniform rental workwear.

We have to be innovative, and we have to create uniform solutions that our customers want to wear. And we think we've been pretty successful in doing that. Paul gave a couple of examples in his narrative a few minutes ago.

And so it really starts with innovative products and solutions. And we feel like that's - we've been pretty good at that. That's going to be important to continue to do that as we move forward.

As far as how much opportunity is still out there, we feel like there is quite a bit of opportunity. We continue to introduce new products like our Carhartt, like our scrub rental, like our Chef Works products for rental. And it takes a while to get those fully penetrated and fully rolled out.

And so there's a lot of runway in just our existing products, and that doesn't include any products that we will continue to invest in and look for.

Nate Brochmann

And I would assume along with that, though, like the word of mouth in terms of people within the industry even talking, that's got to kind of help accelerate that runway a little bit, right?

Mike Hansen

Well, I would say that the more prospecting we do, and the more that we talk about our solutions, yes, the better that can become. And that - from a word of mouth standpoint, that gets around to different decision makers.

Nate Brochmann

Okay. And then second question is, kind of when you originally announced some of the upfront cost-related SAP, I think there might've been a little bit of initial worry about what we can do to offset that.

I mean, clearly, with your guidance going into next year, that's pretty strong. I would assume that you have uncovered some offsets to kind of help balance some of those costs, and obviously, you're really great in terms of the gross margin expansion as well.

Could you talk about maybe some of those things underneath the covers that you are able to find to offset that, particularly given some of the headwinds you're facing in terms of the lost day and the energy costs, et cetera?

Mike Hansen

Sure. I would say, Nate, that it's not that we've uncovered a lot of different things; it's just that - I'll go through a couple things. We won't have the incremental IT investments that we would typically have, and that's helpful.

We expect certainly improved performance out of our First Aid and Safety business, as we lap the acquisition of ZEE. Again, we expect to see improved performance certainly, and we expect to see improved performance out of our Fire business. Those certainly will help. And you are seeing that as part of the guidance.

We will certainly get some natural leverage from the growth in our Rental segment and that will help. And then we're also continuing to control our costs and manage our cost structure, and we've been pretty successful at that and we'll continue to be successful at that.

So there are a number of different things that go into this and help offset some of the headwinds that we've talked about. But I think - there's nothing - there's no magic silver bullet that we've got that we've all of a sudden uncovered. It's continuing to do what we do.

Nate Brochmann

Great. Thanks for all the extra color. I appreciate it.

Mike Hansen

Okay.

Operator

We'll take our next question from Sara Gubins with Bank of America Merrill Lynch.

Sara Gubins

Hi, thanks. Just a follow-up on that - at the end of your last comments you said that you're -- overall, you're focused on managing the cost structure. Could you add in a little more detail about where - aside from natural leverage in the business, you are able to do that?

Mike Hansen

Well, aside from investments that we choose to make, our expectation is that we're going to grow our G&A about half as much as revenue each year, and we've been pretty good at that. Again, aside from certain investments that we want to make.

And so a lot of it comes from managing that G&A structure. A lot of it comes from an active Six Sigma program where we are constantly looking for small incremental wins to medium size wins. And those Six Sigma process improvements come in our production, in our plants, they come on our routes, they come in all different places.

We have a lot of people who are involved in that Six Sigma program looking for small to medium size wins. And that will certainly help as we become more and more efficient in all of our processes.

Sara Gubins

Okay. Thank you. And could you give us an update on the pricing environment? Have you seen any changes there?

Paul Adler

Sara, its Paul. Yes, on the pricing front, we haven't really seen anything in terms of a marketable change. So it's been pretty status quo. It's still competitive in terms of national account programs, but that hasn't changed, and really no difference. So nothing, no worthy or anything significant to pass on to you there.

Sara Gubins

Okay. Great. And then just last question, could you talk about your priorities for capital next year?

Mike Hansen

Well, I - Sara, I would say that those priorities will be the same as they have been for fiscal '16. I talked a little bit about that in our prepared remarks. We're going to continue to invest in the business. We're going to continue to do that through a little bit of the P&L, but also through CapEx.

We are certainly going to be looking for acquisition opportunities that create long-term value for us similar to the way we did that in fiscal '16. Our third priority is we will take a look at the dividend, and if history repeats, we will likely increase the dividend this year, because that has been very important to us.

And then lastly, if there are - if there is cash remaining, we certainly will put it to work in share buybacks. But we will look at it in that priority order and making sure that we are always looking to strengthen Cintas for the long-term.

Sara Gubins

Thank you.

Operator

We'll take our next question from Jeff Goldstein with Morgan Stanley.

Jeff Goldstein

Hi. I wanted to ask about the All Other segment, where it looks like you had some strong growth in the quarter. First of all, are you able to provide the organic growth for that segment?

And then secondly, was growth there driven by any large one-off orders in direct sales or was it more broad-based in nature?

Paul Adler

Yes. I can provide you with the organic growth of All Other, it was 8.5% in the quarter. And that All Other, just as a reminder, includes our Fire business and our Direct Sale business. And that Direct Sale business is typically more of a slower grower in our portfolio, but it had a good quarter. It was a little stronger growth rate.

And again, that's direct sale business, can be a little more volatile, so we had some good rollouts of programs in the fourth quarter that helped push growth along and get that organic growth rate up pretty nicely.

The Fire business continues to grow nicely as well. We expect about double-digit growth in our Fire business. And so as a result of growing the top line in both of those businesses, we also saw 100 basis points of operating margin expansion in that segment as well.

Jeff Goldstein

Okay. And then I want to ask about cotton prices, which have actually increased pretty significantly recently. Would you expect any type of headwind to your business if we are able to see kind of more of a sustained period of these higher cotton prices?

Mike Hansen

Well, cotton, we would have to see a sustained increase in cotton, and for a while. So let's talk about specifically for our Rental business, you know, when we think about most of our uniforms, they are a polycotton blend or lower percentage of cotton. So that is - that's point number one.

Secondly, labor is the biggest component of cost out of our garments, and so the materials are not the majority of the cost involved. Thirdly, there's a supply chain. And so we would have to order the fabric. It would be sown into garments, that - and then shipped to our distribution center.

That probably takes somewhere of 8 to 10 weeks. Then there is a turn through the distribution center, and then it gets shipped out our rental locations where it gets generally amortized over some period of time, mostly 18 months.

So there is a quite a bit of time before we would see a sustained cotton impact. And even if we did see a sustained cotton impact, because of the percentage of the cost itself, I don't see that - I just don't expect that that would be that noticeable, and it would have to be a real spike for some sustained period of time.

Jeff Goldstein

Okay. That's helpful. And then I just have one last maintenance question. You had said regarding the national advertising campaign that spending on the campaign would likely ramp up again in fiscal '17. Is that still the guidance, and do you have any color on which quarters would likely see most of that spend?

Mike Hansen

It - we expect that our spend will be about the same in fiscal '17 as fiscal '16, which for the year, is about 25 basis points. I would expect that the largest or the impacts would be the greatest in our second and third quarters.

Jeff Goldstein

Okay. Thank you.

Operator

We'll take our next question from Andrew Wittmann with R.W. Baird.

Andrew Wittmann

Great. So, Mike, thanks for the answer previously about some of the offsets that you had to the margins. Given that those headwinds are pretty significant, I was wondering if you could give us a little bit more detail?

And in the past, you mentioned that the ZEE integrations that you thought that the segment margins could get back up to their pre-ZEE levels, which I guess is - I don't know, 13-ish-percent for the segment?

Is that still the right goal, and what's the timeframe to which you think you can get those ZEE margins? Or to get these significant offsets, are you now eyeing above prior segment margin peaks?

Paul Adler

Andy, its Paul. Yes, as far as ZEE is concerned, I just want to reiterate that we are pleased with that acquisition; everything is on track. We had mentioned previously that we need a full year to get through the integration. And so through May, we're about 75% of the way through.

It's not turnkey, it's not standalone, as you know; it's largely a tuck-in. And so when you have a tuck-in, you have a little short-term efforts in order to get those synergies in the long-term.

And that's definitely what we are seeing in the First Aid segment is that impact, the integration costs, re-routing, goodwill and customers to make sure nothing falls through in the transition. You can't run as fast as you would like to right out of the gate.

But things are on track. We do expect those margins to bounce back. We don't have a timeframe as far as here's the timetable and the quarters and the milestones. But absolutely, we have another quarter of integration in fiscal '17, and we expect to see those margins bounce back.

And baked into our guidance for fiscal '17 is improvements in those First Aid and Safety margins, and some stronger growth rates than you saw in the fourth quarter as well.

Mike Hansen

And Andy, I would add to that, from a Fire Protection Services perspective, we continue to grow that business. And we grow it - we've grown it quite nicely in the last year, Paul talked about it growing nicely in the fourth quarter. And we expect continued operating margin improvement in that business as well, as we gain density in a lot of our different markets.

And as that business continues to do the same thing that our other businesses do, and that is fine product adjacencies, continue to penetrate existing customers, while adding new storefronts. Our National Account Fire business has been very good over the last year as well.

And so there, we expect certainly improvements in the First Aid business, as Paul talked about, but we also expect them in our Fire Protection business, and that certainly will help us in fiscal '17.

Andrew Wittmann

Okay. Thank you for that context. On the capital budget, I think I heard 280 to 320, that compares to $275 ish this year. I'm just curious as - and we know we - I think we had decent SAP spending in fiscal '16.

I think I heard you say that there's 40 expected in fiscal '17, but I still think that's a pretty decent increase and I was wondering what you contribute the delta to?

Mike Hansen

Well, we will be adding capacity like we've talked about. I believe we'll have a couple different facilities open here early in this fiscal year. Those were not full newbuilds, but they were capacity increases. And that will give us some help in the first quarter.

And then we expect to continue to increase capacity because of our growth, probably closer to the end of the fiscal year or into early fiscal '18.

So there's a little bit more capacity spend than we've seen over the last - certainly over the last three to five years, and even a little bit more than we have seen in fiscal '16.

Andrew Wittmann

Okay. Last question, it's been reported that you guys are going to - and you've had the, I think, the Southwest Airlines contract for a while, which, correct me if I'm wrong, it was mostly a direct sale. Last time you guys redressed an airline was I think it was United Airlines, and that was a tangible number that we could see to the P&L.

Is the Southwest Airlines on the same order of magnitude in terms of the contribution? And how should we expect the timing of that to flow through? And maybe any comments you would have on the profitability, is that rollout a major program, I think would be fairly short order.

Mike Hansen

That is a - that's a great success for us in terms of gaining the award for that business. That's - of the impactful piece of that is relatively new. It's early, so I'm not ready to provide any timetable and estimates. But we'll certainly talk more about that as we go through the performance of that business.

But we're early on. Again, we've got to source the product, and that takes some time. And so those big projects don't happen overnight. And in fact, I think we started working on the United program something like 12 to 15 months in advance of starting to ship. So it is a nice program for us, but it's going to take a little time.

Andrew Wittmann

Okay. So the implication there is if United was 12-plus months, this one might not even have a lot of revenue contribution this year, is that fair to say?

Mike Hansen

I think that's a fair assumption.

Andrew Wittmann

Okay. Great. That's it for me. Thank you very much.

Operator

We'll take our next question from Joe Box with KeyBanc.

Joe Box

Hey. Good evening, guys.

Mike Hansen

Hi, Joe.

Paul Adler

Hi, Joe.

Joe Box

So a couple of questions around the Uniform segment organic growth rate. One, is the growth rate for Uniform versus All Other kind of categories within that Uniform segment, are you still seeing the growth rates kind of trend at a similar rate or are you starting to see them diverge?

And two, if I heard you right, it sounded like you highlighted new business wins, better penetration and even retention as kind of the biggest drivers to the entire segment. I'm curious if any of those three things are either accelerating or decelerating?

Mike Hansen

Well, I would say that the fiscal '16, as we've talked a lot about, had an impact on - from our oil, gas and mining customers throughout the year. And that has had a bit of a negative impact on the growth of the Uniform side relative to the whole segment.

So it is a little bit - the Uniform Rental side is a little bit lower in terms of the growth than the average. And we've been able to pick that up through the Facility Services, both in new business and in the penetration, and as Paul said, the retention.

I would say that from the standpoint of do any one of those three stick out dramatically, I would say no. But I would say that the penetration, we have lots of opportunity left. There is a lot of runway to continue to add value to our existing customers.

And we've been very successful at that in fiscal '16, particularly with some of our hygiene products and services like our Signature series, kind of a more front-of-the-house hygiene business.

And I think what I am describing kind of shows itself in the numbers that Paul gave, and that is that the Uniform Rental business was 51% of that revenue last year, it's now 50%. The hygiene was 13% last year; it's now 14%. That's what you are seeing. You are seeing some lost oil, gas and mining customers, but it's being offset by some nice penetration and improvements in retention.

Joe Box

Right. Appreciate that. And then maybe switching gears to the SAP side, I know obviously it's very early on the Uniform Rental side. But can you maybe just talk about the number of branches that you've rolled out maybe through mid-July, and some early impressions or challenges that you might have had with that?

Mike Hansen

Well, we just recently started our pilot, and early indications are that we're off to a very good start. However, we're early. I think I talked about this last quarter. Our pilot is effectively starting with one location and really learning a lot. And assuming that goes well, we will move to several others. So that by mid-fiscal year, our expectation would be that we're kind of ready to start rolling out full speed.

So right now, we're in that early pilot stage with one location. And, like I said, early indications are it's going pretty well. But again, we're early. And I think we'll have more to say about that more than likely at the end of our first and second quarters.

Joe Box

Got it. And maybe I guess in that same vein, clearly, SAP is going to be a big project for you guys over the next couple of years. Your balance sheet is generally under levered. I'm curious if you guys would be willing to do a sizable deal throughout this SAP process or would you pretty much table any sort of major deal until SAP was completely rolled out?

Mike Hansen

Well, I would tell you that this SAP is a big project, and we've got a lot of resources and attention put to that. But you know, opportunities don't come along every day. And if we had an opportunity, small or large, to add value for the long-term benefits at Cintas, we certainly would take a look at it. And again, at the right value, we would certainly love to do M&A that provides long-term value.

That is the same message that we've had for quite a while and that doesn't change during the SAP rollout. It certainly may affect the way we would integrate it. But if we have opportunities that create great value for Cintas, we'll still take a good look at them.

Joe Box

Got it. Thank you, guys.

Operator

We'll take our next question from Scott Schneeberger with Oppenheimer.

Scott Schneeberger

Thanks. Good afternoon, guys. From the press release, we know that - and typically, you guys anticipate a fairly flat economy in the forward guidance. Could you speak to how you think about employment, maybe with regard to oil and gas and mining, and then x-ing that out, how you think about it? Thanks.

Mike Hansen

Well, we - from an oil, gas and mining standpoint, we have seen continued deterioration. But I would say today, that rate of deterioration is slowing, certainly relative to 90 days ago. But as Paul mentioned, we still expect to see a negative 60 basis points to the top line. So that tells you that we don't - we won't feel healed in that area in fiscal '17.

From the rest of the - let's call it economic picture, I would say that it's still a challenging environment. There's not a lot of momentum to it. But I would call it stable. We haven't seen a lot of change today compared to a quarter ago. And so, I would say we're continuing to operate like we have been.

I would say as we look into fiscal 2017, if I were to make a comment about the economy that maybe did feel a little bit different, I would say today compared to, let's call it six months ago, it does feel like there is a bit more uncertainty.

When you think about the - we do - we have seen some ups and downs in employment; no doubt about that. We've seen the European issues; we've seen changes from the Department of Labor in terms of minimum wage and overtime that can have a pausing effect on our customers

We've got the election coming up. It does feel like there is a little bit more uncertainty than there was six months ago. And that's likely bleeding into the bottom end of our guidance range.

Scott Schneeberger

All right, thanks. That's helpful. And then you talked kind of piecemeal as we've gone through Q&A with regard to, say, branding and what quarters that may hit more. Could you speak to - I don't know if you mentioned the quarter with the extra or the one less day, but on a quarterly basis, top to bottom, when might we expect some of the ebbs and flows?

I guess I'm thinking more on expense and how it will impact the margin. But just how we move through the year, is there anything worth pointing out that will be a big factor, just on the sequential basis as we move through the year? Thanks.

Mike Hansen

Sure. I would say a couple things, Scott. Paul talked about a tax rate of 36.7%. That's a little bit higher than last year, but lower than our - maybe our longer-term. I would expect that we are going to see a slightly lower tax rate in the first quarter, followed by something closer to what we've typically guided toward in that 37% range in the last three quarters. So that's maybe one point.

From a Ready for the Workday campaign standpoint, I would say that it is going to - the bulk of it is going to be in the second and third quarters. From an SAP standpoint, we talked earlier about that will be back-end loaded.

So we will have some costs in the first half of the year, but we turn on the depreciation and we turn on the licensing expenses in the second half of the year. So we will see a little bit more pressure in that back half from that standpoint.

As far as calling things out, I think maybe the other thing that I might call out is the first quarter, as Paul mentioned, would have a little bit heavier, from a First Aid standpoint, ZEE implementation and integration costs. But from a quarter-to-quarter basis, I don't know that I would have much more to share than that.

Paul Adler

Yes, I can't recall, Scott, if we mentioned the third quarter is the quarter with the one less workday.

Scott Schneeberger

Thanks. I think you did last time; I just didn't have it in front. So thanks for repeating it, guys. And that color was very helpful. Appreciate it.

Mike Hansen

Sure.

Operator

We'll take our next question from Adrian Paz with Piper Jaffray. Mr. Paz, your line is open. You may want to – did you press your mute function.

Adrian Paz

Hi, this is Adrian Paz on for George Tong. I just wanted to get a little more code on M&A. I know for a long time, Cintas didn't do any acquisitions. And in recent quarters, we've seen a pretty big - well, yes, in recent quarters, we've seen a pretty big uptick in acquisition activity.

I mean, is - are you seeing better valuations out there? And is there any segment that you're targeting growth in through M&A?

Mike Hansen

Well, we - I would say that, as far as M&A goes, it really is opportunistic. So when the opportunities become available, we need to be ready to take advantage of those, and we were opportunistic in fiscal '16, certainly.

We would look for acquisitions in our Rental business, in our First Aid and Safety business, in our Fire businesses primarily. We love tuck-in acquisitions. They are very accretive. And we'll continue to look aggressively for those kind of opportunities, provided they are at the right value.

We might look for bigger opportunities in any of those businesses, again, as long as they provide long-term value for us, and at the right valuation.

Adrian Paz

Also, can you provide an update on Canadian operations? I know that they had been experiencing some headwinds a few quarters back with the currency. Have those - I guess operations there stabilized, and are they, I guess, resuming growth?

Mike Hansen

Well, I would say that the performance of the business there hasn't necessarily been affected by the currency exchange rate. Our business continues to perform well. But we have seen less volatility in that Canadian exchange rate.

I think the negative impact to the top line was 30 basis points. So we're still seeing a little bit of negative. But generally speaking, the business continues to perform well.

Adrian Paz

All right, thank you.

Operator

We'll take our next question from Andrew Steinerman with JPMorgan.

Andrew Steinerman

Hi. Could you just tell us what share count we should use for the first quarter based on the share buyback that was done already? And does your guidance assume any further share buyback?

Paul Adler

Andrew, its Paul. The guidance does not assume any further share buyback. Maybe just to sync up, I don't know if you noticed, but with the earnings release, we have income statement that we enclosed, and there's a supplemental schedule in there that has the computation of diluted EPS.

And if you look at that for the 12 months ended May 31st of 2016, you'll see our computation there for the current year where we start off with income from continuing ops; we reduce it.

And it's about 1.6% reduction to allocate income to its participating securities. And then we divided that number by 110 million diluted shares outstanding.

And so in fiscal '17 for our modeling, we are going to use about that same $110 million or not million dollars, 110 million shares, rather for computation of fiscal '17 EPS.

Andrew Steinerman

Perfect.

Paul Adler

So model your '17 number, reduce it for the income to the participating securities, and look at 110 million shares.

Andrew Steinerman

Thank you.

Operator

And we'll take our final question from Dan Dolev with Nomura.

Dan Dolev

Hey, thanks for taking my questions. I know you don't guide to margin growth, but if I think through the $30 million to $35 million of incremental SAP expense, and I think about what the implied operating margin growth is this year, say, at the midpoint maybe down 40 basis points, if I add back the SAP, I'm looking at maybe 20-ish.

That's still a step-down from what you did last year, even at the midpoint. Is that just conservatism or could you maybe help me bridge through how should we think about that? Thanks.

Mike Hansen

Well, our total incremental margins for fiscal '16 for the company was - were about 20%. Rental, it was certainly higher. Rental was more like 28%. We have talked about, historically, that that incremental margin, we want that incremental margin to be in the 20% to 30% range. If we're higher than that for sustained periods of time, we worry that we're not investing enough.

And I would tell you that, as we look into '17, excluding the SAP impact, we're about in that same range; maybe a little bit on the lower side because of the negative oil and gas impact, because of the negative workday impact.

But generally speaking, we think there are good incremental margins. And at the top end of the guidance, even with the SAP impact, even with the oil and gas, even with the extra workday, there is a slight operating margin improvement.

Dan Dolev

Got it. And I remember last time you said you won't be sitting idly watching the $30 million to $35 million flow down to the bottom line. How do you feel about those today, four months later?

Mike Hansen

Well, I would like to think that the guidance that we have provided is an indication that that's exactly what we have done. And that is not sit around idly waiting for $30 million to $35 million to hit.

But instead, we are continuing to run the business, execute very, very well, improve where we can, and come up with very good results. And we feel good about the business. I think that guidance would tell you that we feel good going into fiscal '17, and our partners still are executing at very, very high levels.

Dan Dolev

Excellent. Thank you very much.

Mike Hansen

You're welcome.

Operator

That will conclude the question-and-answer session. I'd like to turn it back to today's speakers for any additional or closing remarks.

Mike Hansen

Well, thank you for joining us tonight. We will issue our first quarter earnings in the end of September, and we look forward to speaking with you again at that time. Thank you.

Operator

That does conclude today's conference. Thank you for your participation. And you may now disconnect.

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