G&K Services F1Q08 (Qtr End 9/29/07) Earnings Call Transcript

| About: G&K Services, (GK)

G&K Services Inc. (GKSR) F1Q08 (Qtr End 9/29/07) Earnings Call October 30, 2007 11:00 AM ET

Executives

Glenn Stolt - VP and Treasurer

Rick Marcantonio - Chairman and CEO

Jeff Wright - SVP and CFO

Analysts

Michel Morin - Merrill Lynch

Mike Hamilton - RBC

Scott Schneeberger - CIBC World Markets

Ted Kundtz - Needham& Company

David Long - William Blair

Mike Schneider - Robert W. Baird

Operator

Good day, ladies and gentlemen. And welcome to G&KServices Fiscal 2008 First Quarter Earnings Call. At this time all participantsare in the listen-only mode. Later we will conduct a question-and-answersession and instructions will follow at that time. (Operator Instructions) As areminder, this conference is being recorded.

I would now like to turn the conference over to your hosttoday, Mr. Glenn Stolt Vice President and Treasurer. Please begin sir.

Glenn Stolt

Thank you, Sean. Good morning everyone. Thank you forjoining us to discuss G&K's fiscal 2008 first quarter results. As always wewill complete our prepared remarks and follow it with the Q&A session.

Joining me on the call today is Rick Marcantonio, Chairmanand Chief Executive Officer, and Jeff Wright, Senior Vice President and ChiefFinancial Officer.

Before I turn the call over to Rick, I'd like to remindeveryone that this call may contain forward-looking statements within themeaning of the Federal Securities Laws, including statements concerningbusiness strategies and their intended results, and similar statements concerninganticipated future events and expectations that are not historical facts. Theseforward-looking statements are made pursuant to the Safe Harborprovisions of the Private Securities Litigation Reform Act of 1995. Theforward-looking statements in the press release distributed this morningreflect Management's best judgment at this time.

But all such statements are subject to numerous risks anduncertainties, which could cause actual results to differ materially from thoseexpressed in or implied by the statement provided. Additional informationconcerning potential factors that could affect future financial results isincluded in the Company's Annual Report, and from time to time in the Company'sfilings with the SEC.

As always a replay of this call will be available startingtoday at approximately 1:00 PM Central Time through November 29th. You mayaccess the replay by visiting the Investor Relations Section of our website.

At this time I'll turn the call over to Rick Marcantonio.

Rick Marcantonio

Good morning and thank you for joining us. This morningwe're pleased to report strong first quarter results. For the first quarter,revenue exceeded expectations and totaled a record $243.8 million, up 9.3% overa year ago. We also draw very strong earnings that exceeded both ourexpectations and consensus estimates.

Earnings per diluted share were a record $0.58, up almost35% from first quarter a year ago, clearly strong top and bottom-lineperformance. In addition, we delivered a significant improvement in operatingmargin. Our first quarter operating margin was 9.8%. The highest level in 19quarters and the highest level of operating income since we initiated our newstrategic business. We believe an impressive result and further evidence of thesuccess we're having in executing our new strategic visions.

It’s important to note that it’s not just one thing that isworking or a single initiative that we are excited about at G&K. Ourresults are be driven by a number of key initiative. In fact, we have beeninvesting in several key growth and productivity programs tied to our long-termstrategic vision. The result, we continue to gain momentum driving revenuegrowth, expanding margin, exceeding customer expectations and creatingcompetitive advantage.

To start this morning, let me provide an update in a few keyareas. After that Jeff will take you through a detailed review of our financialresults.

First, I would like to start out by talking about our salesorganization. As you may recall, recently, we’ve been very focused onincreasing the productivity of our sales force. As a reminder, we madesignificant investments in expanding our sales force a little over a year ago.Last quarter, we reported that we’ve begun to see early signs of improvementsin sales productivity.

Today, I am very pleased to report outstanding results inthis area. First, sales productivity as measured in average weekly new saleswritten is up approximately 20% from a year ago. This increase in productivityultimately drove an all-time quarterly new account sales record for G&K,eclipsing the high watermark set during fiscal 2006, an outstandingaccomplishment by our sales organization. While this outcome had very littleimpact on our first quarter revenue, it will help drive revenue growth in thecoming quarters. We’re also testing a new sales automation tool, which we planon rolling out in the second half of this fiscal year.

Staying with our sales organization for a moment, we alsocontinue to generate significant momentum in national accounts. As you mayrecall we have multiple national account wins last year. And I am happy toreport they’ve rocked to a great start again this year.

During the first quarter, we signed Honda Canada, RRDonnelly, Gulf Oil and Labella’s Food Distributors to name just a few newnational accounts. We also expanded our existing business with Home Foods bybeginning to serve an additional region for them.

In addition, we renewed our national account relationshipswith the United Rental, Sun Media and Swift among many others. More than ever,these national account wins continue to demonstrate that across North America, customers are increasingly looking toG&K to help solve their critical image and safety needs.

Turning to our direct sale business for a minute, for thequarter direct sales revenue grew approximately 12% driven almost entirely byorganic growth. We’re pleased to report strong gains from our Lion UniformGroup and our field direct sales business.

During the quarter, Lion began new uniform programs with[Ecolab] and SHOW NASCAR just to name a couple. In addition, I wanted toprovide an update on our exclusive strategic agreement with Dockers, San Francisco. As we’venoted before the introduction of Dockers apparel to our customer base, it willbe done in a phased approach.

As discussed, it is a key component in extending ourpresence in the direct sales category. We are focused on building a directsales business model to meet the needs of our customers and to capture a largershare of this important market segment. Today, we have started to introduceDockers apparel through our Lion Uniform Group to their customer base.

As we complete the investments needed to support on muchlarger direct purchase business, we will faith in the offering Dockers apparelto our direct sale catalog customers, who are serviced primarily by our rentalorganization. This phase will likely happen later this fiscal year.

We believe that our exclusive access to this market-leadingbrand strengthens our capabilities and enhances our competitive position in thedirect sale market. Overtime, I also see us introducing the Dockers brand inthe rental segment.

As a side note, our relationship with Dockers San Franciscowas profiled in the September issue of Industrial Launderer, a monthly magazinefor the uniform and textile service industry. The articles focuses on ourDockers relationship as well as the number of other strategic initiatives we'vebeen pursuing to realize our vision to be the market leader enhancing image andsafety in the workplace through innovation.

I invite you to read this article. To obtain a copy, you caneither visit our website under Investor Relations, the featured report sectionor access the Industrial Launderer website at www.ilmagonline.com underarchive.

Shifting gears, it's important to remember that through oursegment at marketing program, we continue to lead the industry in providingcustomers with innovative images safety solutions. I would like to be a bitmore specific.

First, as a result of ProSura FoodSafety Solutions for both food processors and the retail food segment, wecontinue to generate robust revenue growth in the food segment. Our firstquarter revenue with food processors grew organically by well over 10% versus ayear ago.

In addition, we're getting strong interest in BioSmart, ourexclusive line of antimicrobial garments and towels for the food industry. Thisinnovative and proprietary product offering resulted in signing several newaccounts in the quarter, most of them in the retail food segment. And we grewour grocery and casual dining revenue by over 5%, driven in-part by ProSura retail and BioSmart.

In addition, our revenue from ProTectSafety Solutions, which provide customers with flame resistant apparel is upwell over 20% compared to last year. Clearly, our success in offering customersunique solutions is driving overall growth and expanding the market we serve.

Finally, let me spend the moment onacquisitions. As you know, acquisitions remain a key strategic growthinitiative for G&K. We continue to be very active on the acquisitions fronthaving completed three deals over the last nine months. In fact, I'm pleased toreport that the addition of GRANTEX, ALTEX and Leef has gone as expectedand our integration plans are on schedule.

All three of these quality businesses are providing strongrevenue contribution. As a reminder, we'll continue to pursue strategicacquisitions to enhance our overall growth and increase our capacityutilization. We will also continue to look for segment specific direct purchaseuniform businesses.

Before I turn the call over to Jeff, I would like to repeatthat I am very pleased with our strong first quarter performance. We continueto execute against several key growth and productivity initiatives. Initiativesthat have been identified as, important steps in our strategic plan,differentiating us on the competition, enhancing our overall results.

Our focus remains unchanged, lead the industry in providingcustomers exceptional service and innovative emergent safety solutions. Byexecuting against this vision, we expect to generate even greater financialperformance and shareholder returns over the long term.

I would now like to turn the call over to Jeff. Jeff.

Jeff Wright

Thank you Rick. As Rick highlighted earlier, we’re verypleased with our first quarter performance. Total revenue exceeded expectationsand totaled $243.8 million for the quarter, an increase of 9.3% over the lastyear.

Organic rental growth, revenue from acquisitions and strongdirect sale growth drove the increase over the prior year. As expected, ourrental organic growth rate was 3.5% in the first quarter.

New account sales, strong route sales, and solid customerretention drove organic rental revenue growth. This was some what offset by thechange in employment levels of certain traditional uniform wearing industries,which continues to put modest pressure on organic growth.

With that said, we continue to focus on the multiple avenuesof growth to expand our top line, on both on organic and acquired basis

Earnings per diluted share also exceeded expectations, andincreased to $0.58, an increase of 35% from $0.43 per diluted share during theprior year period.

Earnings were above expectations due to significantly higheroperating income. Driven by solid revenue growth, lower merchandise, productionand administrative cost and partially offset by increased selling and interestexpense.

Importantly operating margin for the first quarter increasedsignificantly to 9.8% of consolidated revenue up from 8.2% in the prior yearperiod. This 160 basis point improvement in operating margin was the result ofthe incremental income and fixed cost leverage realized from revenue growth,lower merchandise cost, and productivity benefits achieve from operationalinitiatives. Partially offset by higher selling expenses and ongoingacquisition integration cost.

Rental revenue in the first quarter was $226.1 million, a9.1% increase over the prior year of $207.3 million. This increase was drivenby rental organic growth, additional revenue from acquisitions, and a morefavorable Canadian exchange rate.

Direct sale revenue increased to $17.7 million from $15.8million last year. This 11.9% increase was driven primarily by organic growth.

Rental gross margins for the quarter increased to 36.8% from36.5% in the prior year period. Our production costs positively impacted grossmargins due to the fixed cost leverage from revenue growth, and cost reductionsfrom productivity initiatives.

As expected, margins also benefited from lower merchandiseexpense as we anniversaried higher merchandise costs associated with the strongnew account growth over the past 12 to 18 months. Direct sales gross marginincreased to 28.1% from 23.9% in the prior-year period. This increase in grossmargin was due primarily to efficiencies gained from strong revenue growth.

Selling and Administrative expenses were 21.4% ofconsolidated revenue for the quarter, down from 22.4% in the same period lastyear. Selling and Administrative expenses decreased compared to the prior yeardue to lower administrative expenses, offset partially by higher sellingexpenses.

During the quarter, we also recorded a number of unusualless frequent items that had an offsetting impact on our income statement.These included an expected gain from the sale of property, offset by plantexpenses associated with severance cost related to the move of an additional130 U.S. manufacturing jobs to our Dominican Republic location, severance costrelated to a few corporate personnel moves, and cost for inventory obsolescencein our direct sale business as a result of adding Dockers, San Francisco to ourproduct offering, which in some cases, will replace existing product. Again,these items are planned and had an offsetting impact in our income statement.

Depreciation and amortization of intangibles was 4.9% ofrevenue this quarter, compared to 5.0% in the prior-year period. For those ofyou who track these two items independently, depreciation expense was $9.2million for the first quarter and amortization expense was $2.8 million.

Again, we are pleased to report both a sequential and ayear-over-year improvement in operating margin.

Let me take a minute to detail a few of the specificinvestments we made during fiscal 2007 to positively impact our operatingmargins. First, we are now enjoying the full run rate of office savings fromdeploying handheld technology across our organization. As you may recall,utilizing handhelds allowed us to reduce our workforce by over 100 positions.In addition, we continue to look for additional opportunities to drive higherlevels of customer satisfaction and further productivity benefits from ourhandheld platform.

We also continue to gain incremental income from the fixedcost leverage created by additional revenue growth and the execution ofoperational initiatives to lower our cost structure and drive margin expansion.Let me give you a couple of noteworthy examples.

During the past few quarters, we enhanced our garmentsorting capabilities. This initiative, which is internally called AutoSort Plustook the advanced sorting system we utilized in our modern fully automatedplants, and implemented portions of this system into our older, less automatedplants. In the end, we reduced our production workforce by approximately 50positions as a result of this initiative.

As previously mentioned, we also recently transitioned theremainder of our US sellingoperations from Mississippi to our Dominican Republicoperation. This initiative shifted approximately 130 jobs to the Dominican Republic.We encourage severance and shutdown expenses in the first quarter related tothis project, but we'll capture annual savings of approximately $2 million movingforward.

These are just a couple of examples of how we continue tolook at increasing productivity and improving margins. Importantly, thisspecific investment for plan steps is part of our overall strategic plan todeliver improved financial performance.

Continuing down the income statement, interest expense forthe quarter was $4.0 million, up 0.5 million over the same period last year.The increase is driven by higher average outstanding borrowings as compared tothe prior-year period.

Our higher debt balance is a result of the acquisitionswe’ve completed during the last nine months and also our share repurchaseprogram.

For the first quarter our effective tax-rate was 37.8%,compared to 38.5% last year. We did adopt the new income tax accountingstandard called FIN 48 in the first quarter. The adoption of the standard hadvirtually no impact on our effective tax rate. The adoption did impact ourbalance sheet with income tax reserves move from short-term to long-term andthe reserves growth stop as they are no longer presented net of federalbenefit.

Now, let me turn to our capital structure and cash flow,which remained extremely strong. Total debt of $246.1 million was upapproximately $25 million compared to this period last year. Debt as a percentof total capitalization was 29%.

Total shareholder equity increased to $603.2 million,compared to $555.5 million a year ago. Clearly, our balance sheet provides thecapacity to pursue further strategic acquisitions, fund organic growthopportunities, and repurchase our shares.

Cash flow from operations increased to $14.3 million for thefirst quarter compared to $6.9 million in the prior year. Cash from operationsincreased compare to the prior year period due primarily to stronger earnings,higher depreciation and amortization levels, and lower net working capitalinvestment needed to support the growth from the business.

Capital expenditures were just $2.4 million for the quarter,compared to 9.8 million in the prior year. We expect capital expenditures to bein the range of $30 million to $33 million for fiscal 2008.

Free cash flow defined as cash flow from operations lesscapital expenditure, increased to $12.0 million compare to negative $2.9million in the prior fiscal year. We expect to continue to generate strong freecash flow in fiscal 2008.

Cash flow use for business acquisitions during the quartertotaled $40.3 million. As previously disclosed, we completed the acquisition ofLeef Services during the first quarter. And we also recorded the number ofadjustments to previously executed acquisitions, again, this acquisitionsstrengthens our market position and leverages our existing operations in the Upper Midwest.

As previously disclosed, we initiate the share repurchaseprogram to purchase up to $100 million of the Company’s common stock. Duringthe first quarter, we purchase 257,300 shares. Since inception through the endof the first quarter the Company has bought back 489,000 shares orapproximately 2.3% of shares outstanding at a cost of a approximately $19.1million.

We planned to continue to repurchase shares fromtime-to-time. The timing and the amount of the repurchases will be determinedby the Company’s management based on its evaluation of market conditions, shareprice and other factors.

In addition the company has paid a dividend for 38consecutive years, since going public in 1969. We recently announced the 25%increase in our quarterly dividend, which marked the second consecutive year ofsignificantly increasing our dividend. We expect to increase our dividendperiodically, subject to future financial performance and capital requirements.

The execution against our share repurchase program and ourincreasing dividend continue to demonstrate our confidence in our strategicplan, the strength of our business model, and our commitment to deliveringincreasing shareholder value.

Looking forward we expect revenue in the second quarter offiscal 2008 to be in the range of $252 million to $255 million. This revenueguidance represents a sequential improvement in our rental organic growth rateand a year-over-year increase in direct sale revenue. It also reflects theinitial revenue from the strong new account growth both Rick and I highlightedearlier.

As for earnings, we are expecting diluted earnings per shareto be in the range of $0.53 to $0.57 for the second quarter. Our second quarterearnings reflect continued efficiencies gained from revenue growth, andproductivity savings from ongoing operational initiatives.

In addition the earnings guidance includes higheranticipated merchandise cost from record new account sales in the firstquarter. We anticipate that higher merchandise expense, especially as wecontinue to generate new account growth going forward will impact earningsduring the second quarter and in the back half of the year.

During the second quarter we also plan to install oursignificant new information system at our Lion uniform business. We anticipatethat we will incur fairly significant training, travel and other implementationcost during the second quarter.

Our earnings guidance also reflects our ongoing integrationefforts for the three acquisitions we completed during the past year.

And finally, our guidance includes gradual additionalselling investments, as we continue to expand our sales organization to captureadditional growth opportunity.

It's important to recognize that this guidance represent thesizeable improvement in our operating margin from the second quarter of fiscal2007, and represents earnings per share growth of 22% at the mid-point of ourrange. Furthermore, our guidance reflects a more normalized effective tax ratefor the second quarter between 38% and 39%.

That concludes our prepared remarks, and we would be glad totake your questions at this time. I'll turn it back to the operator.

Question-and-AnswerSession

Operator

Thank you, ladies and gentlemen. (Operator Instructions) Ourfirst question comes from Michel Morin with Merrill Lynch.

Michel Morin -Merrill Lynch

Good morning.

Jeff Wright

Good morning.

Michel Morin -Merrill Lynch

I was just looking at your guidance, it seems like therevenue guidance looks a bit conservative, and we're trying to square that withthe expectation that organic growth should tick up sequentially. And if I'mcorrect, the Leef acquisition was not a full contributor this quarter. So, isthere something in particular that would be holding you back a little bit hereor you're just being cautious because of the employment outlook?

Jeff Wright

Michel, this is Jeff, I will answer the question and Rickcan add to it. I don’t think the guidance is cautious. I think it’s ourestimate of where we think things will be. It does reflect our sequentialimprovement in our rental organic growth rate. Actually, as soon as it ismoving up to 4%, and it includes the impact of all of our acquisitions,including Leef. Leef had, while it wasn’t a full quarter in Q1, it was almost afull quarter. And it obviously includes continued drug sales growth as well, butI think our guidance is realistic and not overly conservative.

Michel Morin -Merrill Lynch

Okay. That’s very helpful. And then, I may have missed thisbecause I jumped on a bit late but, on in terms of pricing, how has that beentrending, both for the industry and yourself?

Rick Marcantonio

Well, we don’t report specific results on pricing. I wouldtell you that the pricing environment feels fairly normal above consistent overthe last year or so. Those are big words that I think I feel comfortable communicatingabout the pricing environment right now.

Michel Morin -Merrill Lynch

Okay. That’s very helpful. And then just finally, I think inthe press release or in the prepared remarks rather, you talked about thewritten sales, weekly sales, growing about 20%, can you remind us how the mathworks on that, if you were to sustain that over the next twelve months, wherethat might take your organic growth rate to, if everything else were to stayequal?

Jeff Wright

Sure. Again, we mentioned our new account sales were atrecord levels, up about 20% over the prior year. And, of course, if we are tosustain that, which I think is, that’s a -- that’s an assumption because thisis an all-time record for G&K for a quarter, but if were to sustain that,it would be, that component of your organic growth would drive up 20%. Nowagain, that’s just one component of overall organic growth. But, I think if youwork through the math that would probably represent a 2 to 3 point increase inyour organic growth rate, again, if you flex through all those assumptions.

Michel Morin -Merrill Lynch

Great. That’s very helpful. Thanks very much.

Operator

Our next question comes from Mike Hamilton with RBC.

Mike Hamilton - RBC

Good morning, everyone.

Rick Marcantonio

How are you? Good morning.

Mike Hamilton - RBC

I was wondering, Rick that you didn’t commented at all onactivity on the direct side. Are we seeing anything in new customer wins there,any project rollouts?

Rick Marcantonio

I am sorry -- I did comment just briefly in the preparedremarks, but I would just kind of go through it in detail. The direct salesbusiness opportunity is one that we are quite excited about. It’s important tounderstand that there is component of it. So the Lion business, which, had a verygood quarter, picked up some major new account wins, I have reported, two forexample were Ecolab and [Saab] and Shell NASCAR. While we have been servicingShell, we’ve serviced an additional piece of Shell.

So those are just two wins in that particular business. Ourdirect sale business that comes out of our field organization also had arecently good quarter, and the combination of both of those drove growth in ourdirect purchase business that was double-digit and I think it was around 12%,and all of it was organic. So, that, you know, in our mind it was a good -- itwas a very good quarter.

One might wonder where we are at in the Dockers rollout,which is what we announced last quarter, and I will just remind everybody theway we are going up against the Dockers’ opportunity is we are trying to do itin a phased approach because there are investments that need to be made inorder to capitalize on it over the long-term. And so, if you think about it,sort of, in maybe three phases, we are in phase one right now. We haveintroduced Dockers at part of our Lion Uniform product offering for our uniformdirect purchase business.

We are building more infrastructure and making moreinvestments to be able to roll Dockers in addition to other products into acatalog, a much more enhanced catalog offering, which will be sold by primarilyby our rental organization and that should happen sometime in the second halfthis fiscal year. And then, over the longer-term, I’d expect Dockers to be partof our rental operations. We might have a Dockers product in our rental productline as well.

And then, I guess the only other part about direct purchasesas, you know, this is a big quarter for us in terms of our outerwear promotion.And our revenue, I mean in the second quarter -- excuse me -- and our revenueprojections for the second quarter include a nice increase in our outerwearpromotion, which is a big promotion.

Mike Hamilton - RBC

On the new account wins, is there any particular quarterlybulge when delivery comes or is it slower than some of the big projects we haveseen in past?

Rick Marcantonio

No, I think we had a number of wins not only in directpurchase but rental that we are managing through the execution. The only timethat it becomes a time period where it’s difficult to execute it’s breakeven inthe hauling time period, pretty much the month of December, it’s a verydifficult time to do a lot of new product installation. But other than that wepretty much see it as a regular ongoing kind of thing. If we had anintroduction like we had a years ago with Delta, where I had report thatseparately and tell you that, but everything else is kind of an even flow.

Mike Hamilton - RBC

Thanks. I was wondering if you had a feel for foreigncurrency impact on the operating income line in the quarter?

Rick Marcantonio

Yeah, I think Jeff would like to comment on that.

Jeff Wright

Sure. And maybe I can comment both on revenue and NOI. ButI'll comment, I guess from a kind of an EPS perspective. On a year-over-yearbasis the Canadian dollar has clearly strengthened against the US dollar. Froma EPS perspective, it's probably a little just shy at $0.02 over earnings pershare. So, and are kind of moving from 43 last year to 58 this year, again, mycalculations suggested $1.07 and $1.08 was the impact from that positiveCanadian exchange rate.

On the revenue side as you know, we factor out foreignexchange out of our organic growth rate. So, our organic growth rate is a, kindof, transparent peer number on a kind of a same-store basis. But it would havehad about a 1.3% impact due to the FX, so, in other words if didn’t exclude FXour organic growth rate would be close to 5%. And I know that, I'm not sureeverybody in the industry excludes that from their organic growth rate, but wedo. So that’s the impact on revenue.

Rick Marcantonio

Thanks. If we could come over to CapEx, where you guys havejust done a great job. Your implication on four years suggests you're going upto above as higher run rate as we have seen in recent years. So, are there anyparticular projects worth noting there?

Jeff Wright

We were very low, maybe as you are pointing out our CapExwas low in Q1. And part of that was this, I mentioned in some of the preparedcomments, there is one unusual item, we sold some property that tended tosoften that CapEx number, gets netted in there. But, we do have in the outquarters, we got this implementation of this new system at Lion Uniform Group,there is some spending there.

And we do have one plant that’s scheduled to kind of startup near the end of the fiscal year. So, at this point that’s in our forecast aswell, we have not made a firm commitment on that, but it's in our forecast. So,the CapEx will probably be a little bit greater in the out quarters here.

Rick Marcantonio

But. I would call those tweaks, rather than major shifts interms of a change in our behavior.

Mike Hamilton - RBC

Right, thanks. Last one, can you comment on fuel and energy,both in quarter and your feelings as you look into the year?

Jeff Wright

Sure, the energy kind of seems to have abetted to a degree,when you compare Q1 to last year's Q1, it actually is slightly positive on apercent of revenue basis. We’re obviously a bit concerned about gasoline, oilis up significantly, and you can kind of see a little bit of it in the forwardcurves here. We've built that into our Q2 guidance, so we don’t a have a lot ofconcern about Q2, but maybe a little bit more concern about Q3 and Q4. Again wehedged a decent portion or close to 50% of our gasoline usage, so we’reprotected to some degree but the gasoline price levels are a bit concerning.

Mike Hamilton - RBC

Well, great execution. Thanks for the insights.

Jeff Wright

Thank you.

Operator

Our next question comes from Scott Schneeberger with CIBCWorld Markets.

Scott Schneeberger -CIBC World Markets

Hey, thanks and nice work on the quarter.

Rick Marcantonio

Thanks, Scott.

Scott Schneeberger -CIBC World Markets

I guess jumping back to direct sales, Rick, you mentionedyou will have the outerwear promotion in fiscal second quarter. What type ofthe gross margin impact will that have, you’ve been running in the high 20s,will it move it significantly one way the other?

Rick Marcantonio

It might goose it up just a little bit.

Scott Schneeberger -CIBC World Markets

Okay.

Rick Marcantonio

I wouldn’t lookfor a significant increase in thatmargin.

Scott Schneeberger -CIBC World Markets

Alright. Thanks on that. And could we just go back over, Iguess the one time items in the quarter, Jeff, I believe you said that theywere a near exact offsets. But, is there any more quantification you can put onthe gain on sale offset by I guess each of the severance cost items?

Jeff Wright

Yeah. I'd rather not get in to specific quantification ofeach item, but just again to reiterate, there was a gain on sale of a piece ofproperty we owned that no longer fit into our long-term plans. And that didgenerate a gain. And then we incurred a number of one time expense items as well.And I'll just go through them again quickly, but the movement of 130 jobs from Mississippi to the Dominican Republic, there waspretty significant severance cost associated with that. There is also someseverance cost here, corporate for a couple of corporate personnel moves thatwe made.

And then, finally, with the introduction of the Dockers SanFrancisco product line that, that’s obsoleted or replaced a little bit of ourexisting product and so we took our inventory reserve against that. And thosethree items really offset against that gain. Actually the one thing that willpop-out for you when you see the 10-Q is that the gain actually was in ourCanadian operation and all of the expenses where in our US operations.

So, there is an impact on our US and Canadian margins that youwill see when you see the Q, we don’t disclose those yet when we do our pressrelease here, but when the Q is filed you will see that impact.

ScottSchneeberger

I think -- and we were just talking purely on the P&Ljust now as far as the assets?

Jeff Wright

Yeah, that’s right.

ScottSchneeberger

Okay.

Jeff Wright

All of the P&L.

ScottSchneeberger

And then, just moving into this next quarter, I am sureyou’ve obviously grabbed it in your guidance, but are there any more unusual orone-time item trickling into that?

Jeff Wright

No, in terms of Q2, I don’t think that there is anythingsignificant as in the Q2 guidance. I guess, I was just getting a high sign frommy cohorts here that in with this we talked about in the guidance a bit, but wedo have this fairly big systems implementations outlined. There will be someextra cost there, and so that may be one item that pops out a bit.

ScottSchneeberger

I agree. Thanks. Thanks for the -- all those (inaudible) Iguess just Rick, you know you said I think over the last, may be couple ofquarters, you’ve been taking your foot off of the gas pedal on as far as newsale tires, just waiting for the productivity come through. It sounds like youare very pleased with the quarter, you shot the press release and in yourprepared remarks, indicated that you might go back in that direction again, Iguess, can you just take us a little deeper on that for a sec?

Rick Marcantonio

Yeah, I think that you framed it correctly. The foot is backon the gas pedal. I think it’s the right way to, you know -- we will do itgradually, I mean, as I mentioned to you over the last couple of quarter, Ithink we added in one or two other quarters a year or so ago, we had it toomany, and we had some difficulty digesting that, and so you’re going to see acontinued investments in our sales and marketing organizations and I would lookat it as more gradual just to make sure we can digest or similarly add thosepersonnel into our organization. But, we are going to -- we are and willcontinue to invest in that organization, and our national accounting.

ScottSchneeberger

Thanks very much.

Rick Marcantonio

You're welcome.

Operator

Our next question comes from Ted Kundtzwith Needham & Company.

Ted Kundtz - Needham& Company

Hello, Rick and Jeff.

Rick Marcantonio

How are you?

Jeff Wright

How are you?

Ted Kundtz - Needham& Company

Couple of questions.

Jeff Wright

How are you?

Ted Kundtz - Needham& Company

Very good doing fine. Thanks. Our national account, couldyou tell us what percent of revenue national accounts now constitutes?

Rick Marcantonio

I think, I (inaudible) confirmed, I think it's about 12%,they'll be doing on one hand.

Ted Kundtz - Needham& Company

Okay. Yeah, it was around 14% earlier, I didn't know ifthat's an increasing number or a decreasing number of your revenue?

Rick Marcantonio

Hold out one second, let me just calculate. It's about 15%of our revenue.

Ted Kundtz - Needham& Company

About 15%. Okay.

Rick Marcantonio

And it’s growing.

Ted Kundtz - Needham& Company

And it’s growing, right. Does that put any pressure on yourmargins? Is a pressure there in winning that business?

Rick Marcantonio

No. I'll speak to you in sort of general terms, and then ifJeff wants to add anything he can. We've been asked often as we change our mixto move, to add more direct, excuse me, with more national accounts I think ona negatively impact our profitability. And the answer is we don't believe so.We have done, as you would guess, we do pricing models on our business, andthere are some components of a national account that are different than smalleraccounts, and I'll just remind you of a couple of them. We've talked about inthe past, national accounts typically don't have bad debts.

They typically stay with us much longer, and are typicallymuch larger stocks which increases our efficiency. Those things, sort of impactpositively impact the profitability of those accounts. So, while you might haveto price aggressively to get some of that business that's offset by some ofthose positive things that don't exist with some of the smaller accounts. So,we’re now looking it as a profit change. The only thing that happens with anynew business is we have to make the investment for new business. And thequarter after we introduce it and that’s typically for the new garments and theamortization and the incentive award and the stuff like that, but nothing otherthan that.

Ted Kundtz - Needham& Company

Okay. That kind of lead to my next question about your, kindof, target margins going forward. It looks like certainly in the next quartermargins will be down a little bit. You got increased revenues and you aregiving lower guidance on EPS and you explained why? And I was just wondering,beyond that where do you see the operating margins swinging back? Do you feellike you’re going to get nicely over 10%, sometime in the latter part of thisyear or is that a next year goal or is it a goal at all?

Rick Marcantonio

It is a goal.

Ted Kundtz - Needham& Company

Can you assure? Ineed your long-term gains on margin goals?

Rick Marcantonio

Again, I am not going to peg a particular quarter and thereason, our goals are not to just get our margins back to 10% period, it’s toget our margins above 10%. But I think the reluctance we’ve always had incommunicating a specific target by quarter is, as you can see, we have beenmaking investments behind the scene. I put it down a pretty steady or I puthand-cuffs on our conversation about what those investments have been, until wemake those investments.

But we’re making investments in the business that eventuallywill build up sort of stronger business. That’s some of the reasons why we havehad improvements. But our goals to have year-over-year improvement in ourgross-margin, I mean in our operating margins and in any one quarter it mighttake a little bit, but we are not taking our margins backwards.

Ted Kundtz - Needham& Company

Yeah. I wasn’t looking for a quarterly projections, I waslooking for more of a longer term target range that you may have?

Rick Marcantonio

I think, all I would feel this is again Rick. All I feelcomfortable is our goal to get this in to double-digit operating margin rangesconsistently. And whether that’s 10 or 12 or 15 depends on when we’re talkingabout and I won’t go beyond that.

Ted Kundtz - Needham& Company

Okay, then, one last question. Just in terms of the directsales, effort here that you’ve got, I know it’s potentially a big area ofgrowth for you. Is there anything that you are thinking about beyond theDockers arrangement that you could grow this business faster?

Rick Marcantonio

Yeah.

Ted Kundtz - Needham& Company

Good. Okay.

Rick Marcantonio

Again this is Rick. I don’t mean to be not responsive. But Ithink that what you need to think about Dockers is just part of our directpurchase strategy. It is not our direct purchase strategy in its sincerity. Sothere are elements to building a much stronger direct purchase business that we’rein putting together or working on buying the string.

And I’ll just, kind of, just from 40,000 feet I will tellyou there is a direct purchase uniform business model, which is the businessthat build direct purchase offering from scratch. They design the garments,they source the garment and there is sort of a mix and match or one thatrequires a lot less design, which is typically being serviced out of a catalog.

And those two are two very different businesses. They aremanaged differently. The resources that you put into it are more muchdifferent. You can see Dockers going into both those businesses. But as itrelates to the first one the uniform side, that’s where you’re likely to see usexpand into new segments. You’ll see us acquire other businesses whereas on thecatalog side you’ll see more like product offering extensions as we build outour catalog offering.

Ted Kundtz - Needham& Company

Okay. Great. Thank you. And just one last question, if Icould?

Rick Marcantonio

Sure.

Ted Kundtz - Needham& Company

Anything worse. Areyou seeing any further weakness in the either the automotive or the industrialmanufacturing sector? Those are the two sectors you mentioned last quarter, whowere particularly weak for you, any change going on there, it getting worse orthe same?

Rick Marcantonio

I'll say we probably feel pretty the same. Instead of thecontinuation, what we have seen.

Ted Kundtz - Needham& Company

Okay. Thanks very much.

Rick Marcantonio

You are welcome.

Operator

Our next question comes from David Long with William Blair.

David Long - WilliamBlair

Hey, guys good quarter. It's Dave Long for Bruce Simpson.

Rick Marcantonio

Thank you.

Jeff Wright

Thank you. Good morning.

David Long - WilliamBlair

I know you guys no longer quantify the add staff metric, butlast quarter we had talked that it was down, I think, sequentially. Can youguys just maybe quantify how that metric is trending in the current quarter orthis past quarter?

Jeff Wright

Maybe just a little bit of color, this is Jeff. And it kindof tallies in the last question, that we still see little bit of softness insome other segments out there, particularly automotive, some of the industrialsegments. So, it continues to be weaker than what we would like, and probablywhat has been historically. But we continue to really focus our efforts onthose growing segments. Segments that are really valuing our value propositionaround image and safety, and looking for growth in other areas.

David Long - WilliamBlair

Okay.

Rick Marcantonio

And I want to add this, we've reported 3.5% organic growthfor the quarter. I will tell you we exited the quarter at a higher rate andwe've done that. And we've give you guidance that says we will do 4% organicgrowth. So, we are not saying, whatever is happening in the economy has ahandcuff on our ability to move our organic growth up. We believe ourinvestments are working and driving growth in the areas we need to get growthfrom.

David Long - WilliamBlair

I see. And you talked about kind of auto being littlelackluster. But the food segment area Rick you've talked about being particularstrength, unlike the couple of quarters has that food segments spilled over tomaybe education and cafeterias any new pickups from this staph infection, and superbugthat's been in the news lot lately?

Rick Marcantonio

I can't really speak to that, but I can tell you that whenwe introduced ProSura to the food processors a number of years ago, two orthree years ago, we've seen a steadily increase. And it’s attractiveness tothem and driving new business for us. We put a modified version of that programinto food retail, where there is a lot of sort of food processing been done atretail. And we're just starting to get some of benefits from growth in thatparticular area.

It’s even been stimulated more by Biosmart which was theproduct that we introduced last quarter, which has the microbiological, it hasthe ability to kill microorganisms, in when they become in contact withbacteria and things like that. And we have a chance to rejuvenate that productwhen we bring it back through our wash formula.

And that sort of stimulating interest now in the food retailareas where they would use it for things like toweling systems and also aprons.And that’s kind of the area we're seeing additional interest by some of our newofferings.

But, again we're continuing to work on things behind thescenes that I think will drive both performance in the food area. The other is,we're having a lot of success with our FR garments. That area was up by, Ithink have reported about 20% in the first quarter. So, there are number ofareas that we're seeing positive growth in.

David Long - WilliamBlair

Okay. And one last question is just for Jeff. I noticedinterest expenses was up a little bit year-over-year, and I know it depends alot on acquisitions and the share repurchases, but how are you guys modelingthat rest of the year or how should we be thinking about modeling that for therest of the year?

Jeff Wright

Well, I think in terms of the rest of the year we had theincremental debt from the three acquisitions we have done over the last ninemonths was pretty well in the full quarter. So, you have got to get close to afull quarters worth of impact of interest expense from that. We also continueour share repurchase program. About half of the repurchases we made for thequarter, the interest expense was in the first quarter, but the other half wasprobably only in a month or so maybe in a little bit less than month.

So, there is a little bit of incremental expense coming fromthe share repurchases, and then, of course you’ve got the impact of ongoingcash flow that’s going to reduce your debt levels. So, I would tell you that ifyou modeled it out it kind of start where we were in Q1 and share repurchasessomewhat offsetting the cash flow from operations but net-net interest expenseslowly moving down as you move through the year.

One item that just maybe tied into that just related to ourshare repurchase program, but folks might have a question on what the impact ofthat was to our EPS. It was a positive impact to EPS, however, it was prettymodest in Q1. In fact, we would calculate maybe two-tenths of a penny in thatrange when you take the impact of the shares but less backing off the increasedinterest expense as an offset. So, we reported $0.58 of earnings per share andactually with or without the share repurchase program it would have been $0.58anyway.

And then it’s going to have an increasing impact here in Q2and moving forward.

David Long - WilliamBlair

Okay. Thanks for the color.

Jeff Wright

Thank you.

Operator

Our next question comes from Mike Schneider with Robert W.Baird.

Mike Schneider -Robert W. Baird

Hey, good morning guys, and congratulations on a nicequarter.

Jeff Wright

Thank you.

Rick Marcantonio

Thanks, Mike.

Mike Schneider -Robert W. Baird

First, just I apologize if I missed it, route salesproductivity, Rick you mentioned sales productivity overall was at 20% growth,was that the professional sales force or the route sales force or both?

Rick Marcantonio

It was the professional sales force. That’s the new businessgenerated by our sales organization. While we don’t break-out the components ofroute sales, it basically was, I think the highest was right about one of ourlargest quarters ever and I think -- just give me one second enough, it was upa double-digit.

Mike Schneider -Robert W. Baird

Okay.

Rick Marcantonio

Which confirms what I’ve been saying all along, that theroute sales was not a one-time or short-term opportunity. It continues to be anopportunity in our business?

Mike Schneider -Robert W. Baird

Right. So when you drill down into the organic growth andthe acceleration that appears to be under way, can you give us a sense now ofat least just qualitatively, is it primarily the ancillary products that aregrowing faster than average or indeed are some of the new markets for theuniform business? Can you drive in that business to match the average growthrate?

Rick Marcantonio

Well, our new sales are being driven both from justpenetrating our customer segments that we’ve been in, but also our newsolutions, alright. And our professional sales force arming them with productofferings that no one else in the industry has, has clearly contributed to ourgrowth, I mean, you just clearly, I mean, I gave you our increase in foodprocessing for the quarter was up over 10%, I mean, you are not doing that byjust having a standard overall program.

So, our new programs are definitely helping us, as itrelates to, and those programs are really what route sales are all about. Routesales are selling additional solutions whether they be restroom supplies orpaper products or mats or toweling systems. And we’ve made, you know, while wehaven’t spoken to them with the kind of same vigor that we’ve talked about ournew segmented marketing effort like ProSura, we have introduced new restroomsupplies, for example, a whole new suite of products for restroom that arehands free, that are really are quite interesting.

So, those are the two areas that come to mind. And then, youknow, there are also our new sales are being driven in direct purchases, whileLion continues to pickup new customers by offering. And we’re slowly gettingLion involved with some of our customers segments where we have lots ofbusiness today. So, those are the three primary areas.

Jeff Wright

Yeah. Maybe just tack on to it, Michael, I don’t know,forget that your question or not but certainly on the route sales side where weare trying to penetrate additional products and services into existingcustomers that tends to be the ancillary products and services and that our newaccount sales tends to be driven or led by garment programs. And I think Rickwas trying to articulate that many of the new programs are being led by some ofthe new ProSura and BioSmart and other products that we’re offering ourcustomer base.

Rick Marcantonio

Yeah. I think that just to be very clear. New sales by ourprofessional sales are typically more oriented towards garments and ancillaryproducts are secondary offering like mats and restroom products and things likethat. I am sorry. Hopefully, that clarifies.

Mike Schneider -Robert W. Baird

So, is the growth rate of the garment business matching orexceeding the growth rate in the ancillary products today? I am trying to get asense of what’s driving the mix or which way the mix is shifting?

Rick Marcantonio

Yeah. Michael and we don’t break those out between garmentsand ancillary products. But, again, you know, we had a -- if your new accountsales are primarily garment driven and your route sales are primarily ancillaryproducts, and we had a really blowout, maybe, the little bit strong of a termbut really strong first quarter, then, that's a big driver for us here in thefirst quarter.

Mike Schneider -Robert W. Baird

Okay. And then, national accounts. What were nationalaccounts up during the quarter? And I'm sorry, I missed what percent of salesthere are today?

Rick Marcantonio

We reported that national accounts about 15% of our revenuetoday. And they were up double-digit, strong double-digit. Strong teensdouble-digit, which they've been for a quite sometime, I mean, I only havethis, I mean we've reported strong growth at national accounts and it continuesto be strong.

Mike Schneider -Robert W. Baird

And then, the guidance for next quarter and the grossmargins, it looks like you have picked an acceleration, as a result of the newaccount sales but there is an equal loss that I guess of sequentially lowergross margins. Is that more a function of the day-to-day garment cost beingdeployed on local accounts or is that, I guess, is that indicative of thenational account pricing beginning to be a greater influence on the margin mixor both?

Jeff Wright

Yeah. And I'd say it’s not the ladder which is the nationalaccount pricing. It's primarily that our new account sales are very strong, andthe incremental merchandize cost associated with that will began to impact ournumbers here in Q2 and moving forward. So that will have an impact on our grossmargins. And then, also, I think there was a comment earlier on our operatingmargins, obviously from Q1 to Q2, we'll be down a little bit. And the other reasonsare, well, we mentioned on the call which is the implementation of the newsystem at Lion Uniform and also some acquisition integration costs that arehappening.

Mike Schneider -Robert W. Baird

Okay. And can you quantify the acquisition integration costsyou expect in Q2?

Jeff Wright

No, sorry and in fact some of the actions we need to becareful, they need to be announced to employees in the right way and so forth.

Mike Schneider -Robert W. Baird

Okay. And just all expectations are clear, Jeff youmentioned that if you sustain the 20% growth in sales productivity that wouldadd 2 points to 3 points is that a kind of realistic expectation for us tostart modeling? And I presume that’s over a 12 month period just given the waythe cycles work correct?

Jeff Wright

Yeah, right Mike. That would be over a 12 months period. Wehad a very good quarter in Q1, it would be unrealistic, it could be probably astretch to think that we can perform at that level consistently over a numberof quarters. Our goals are to do such, but it would probably be unrealistic.So, I wouldn’t be putting that into your expectations.

Mike Schneider -Robert W. Baird

Okay. And then I guess just final question. Can I try andget some more detail on the Dockers role. Can you give us some qualitativesense as to what this is hitting the numbers in the first half of the fiscalyear? And I guess when you turn that curve from expenses to probably greatercontribution out of that program?

Rick Marcantonio

The Dockers contribution to volume and profits in the firsthalf of the year is minute. Remember that none of the catalogue business willbe in there. We’re basically introducing it as part of a uniform program inLion. So, it has to be a uniform program, not just a catalogue offering. And ithas to become incorporated as part of the uniform offerings, so that takestime.

The catalogue business, we have not pegged the date, we’relikely to roll out some of it some time in the second half of the fiscal year.And when we get to a point where we’re comfortable knowing when that is, wewill talk to the quarter and it’s potential impact in sort of macro term, interms of how big it is in the quarter. But our second quarter guidance reallydoes not reflect any kind of unusual activity from it.

Mike Schneider -Robert W. Baird

Okay. Thank you again.

Rick Marcantonio

You’re welcome.

Jeff Wright

Thank you.

Operator

Our next question comes from Michel Morin from MerrillLynch.

Michel Morin -Merrill Lynch

Yeah. Thanks for the follow-up. I just wanted to check youtalked about productivity gains, is there can you quantify that a little bitfor us?

Jeff Wright

Michel, this is Jeff, I guess, you know, we mentioned a fewthings during the conference call script, productivity gains that we’ve got outof our handheld unit, well over 100 positions that have been eliminated. Someproductivity gains, that we’ve got out of our plant operations through our AutoSort Plus initiative, about 50 positions.

And then we also talked a little bit, this is more of a gainmoving forward. But the 130 positions that have been moved from our Mississippioperation to our Dominican Republic operation, but then as we mentioned thatthose 130 would result in a couple of million dollars roughly of savings movingforward.

Michel Morin -Merrill Lynch

Right.

Jeff Wright

So, I guess, beyond that where you looking for somethingelse?

Michel Morin -Merrill Lynch

I was specifically interested on sales force front, youknow, I did pick up on the handhelds. I was wondering if there was, when youlook at sales per sales person. What are we looking at in terms of improvementthere?

Rick Marcantonio

I reported in my prepared remarks that our productivity forthe sales organization, and that’s the professional sales organization, not theroute side of the business, was up 20%.

Michel Morin -Merrill Lynch

The 20%.

Rick Marcantonio

That’s the point.

Michel Morin -Merrill Lynch

All right. Okay.

Rick Marcantonio

Which was good.

Michel Morin -Merrill Lynch

That’s fine. Thanks very much.

Rick Marcantonio

Okay. You’re welcome.

Operator

I’m not showing any further questions at this time.

Rick Marcantonio

Okay. Then in closing, then I would just want to thank youall for joining us today. As I indicated in my prepared remarks, we areextremely pleased with our strong first quarter results. We are off to a solidstart in fiscal 2008. And we look forward to reporting to you our secondquarter results sometime in late January. Thank you very much. Have a greatday.

Operator

Ladies and gentlemen thank you for your participation intoday's teleconference. This does conclude the conference you may nowdisconnect. Good day.

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