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Cintas Corporation (NASDAQ:CTAS)

Q4 2008 Earnings Call

July 15, 2008 5:00 pm ET

Executives

William Gale – Sr. VP Finance & CFO

Michael Thompson – VP & Treasurer

Analysts

Kartik Mehta - FTN Midwest Research

Andrea Wirth – Robert W. Baird

Ashwin Shirvaikar – Citigroup

Scott Schneeberger – Oppenheimer

Michel Morin - Merrill Lynch

Gary Bisbee - Lehman Brothers

Brandt Sakakeeny - Deutsche Bank

Greg Halter - Great Lakes Review

Operator

Good day everyone and welcome to the Cintas quarterly earnings results conference call. At this time I would like to turn the call over to Mr. William Gale, Senior Vice President of Finance and Chief Financial Officer; please go ahead sir.

William Gale

Good afternoon and thank you for joining us to hear about Cintas’ fourth quarter of fiscal 2008.

Despite the pressure of increasing energy prices and a sluggish US economy we are pleased to announce that Cintas achieved its 39th consecutive year of growth in sales and profit. For the year revenues increased 6.2% to a record $3.9 billion and earnings per diluted share were $2.15, an increase of 3% over the amount in fiscal 2007.

In the fourth quarter total company revenues increased over 6% on a comparable work day basis. Earnings per diluted share in the fourth quarter were $0.58 compared to $0.57 last year. Last year’s fourth quarter results included a $6.2 million pre-tax benefit from the termination of a forward interest swap that increased last year’s earnings per share by approximately $0.02.5. Excluding this unusual item the earnings per share growth for this year’s fourth quarter compared to last year was over 6%.

Joining me today is Michael Thompson, Cintas’ Vice President and Treasurer. After Michael and I provide some additional commentary on the quarter we will then open the call to questions.

Despite the continuing impact of rising energy prices the company’s total gross margin was 42.9%, the same as last year. Energy costs for the fourth quarter were over 4% of revenues, versus 3.4% in the prior year’s fourth quarter. For the total year energy costs were approximately 3.6% versus 3.3% for the entire fiscal 2007. We also did experience higher energy costs as we moved through our quarter which has increased even further so far this fiscal year.

We are also seeing increases in other costs such as in hangers and capital equipment. While we are attempting to pass on these increased costs through price increases, the sluggish economy and the aggressive prices being offered by our competitors continues to make passing on such price increases difficult. Our financial condition continues to be very strong. We are generating substantial cash flow and keeping our debt capacity available for opportunities that may arise for additional acquisitions, share buybacks or more rapid expansion throughout the world.

Our view of fiscal 2009 is tempered by the continuing pressure of increased energy and other commodity items as well as a deteriorating economy. We anticipate that these conditions will persist throughout the year. However despite these difficulties we believe that Cintas will grow both its top and bottom lines. As a result we are setting our initial guidance for fiscal 2009 to call for revenues in the range of $4.1 billion to $4.2 billion and earnings per diluted share of $2.22 to $2.30.

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 filings with the SEC.

Now I would like to turn the call over to Michael Thompson for further discussion of our results.

Michael Thompson

Thank you William and good evening everyone. Total revenues were $1.01 billion for the quarter, a 4.7% increase over the $964 million reported for the fourth quarter of last year. However when adjusted for having one less work day in this year’s fourth quarter as compared to last year’s, revenue growth was 6.3%. Total company internal growth was 5.2% during the fourth quarter and 4.6% for the year.

As a planning note for next year, each quarter in fiscal 2009 will have 65 work days. As such there will be one less work day in fiscal year 2009; 260 versus the 261 work days in fiscal 2008. The first quarter of fiscal 2009 will have one less work day then the first quarter of fiscal 2008 which had 66 work days. All other quarters will be the same with 65 work days in each.

We classify our businesses into four reportable operating segments; rental uniforms and ancillary products, uniform direct sales, first aid, safety and fire protection services and document management services. Uniform direct sales, first aid, safety and fire protection services and document management services are combined and presented as other services on the face of the income statement. Detail for these operating segments is provided in the supplemental segment data included with the release.

The rental uniforms and ancillary products operating segments consists of the rental and servicing of uniforms and other garments, mat, mops, shop towels and other related items. Our restroom and hygiene products and services are also included within this segment.

Rental revenues were $711.7 million for the quarter compared to $696.8 million in the fourth quarter last year. When adjusted for one less work day this represents a 3.7% increase over the fourth quarter of last fiscal year. Factoring out acquisitions made over the last 12 months, our rental organic growth rate was 3.6% for the fourth quarter and 3.4% for the year. The fourth quarter internal growth rate represents a slight decrease from our third quarter rental organic growth rate of 3.8%. The difficult economic environment is certainly affecting our customers.

Our lost business and ad-stop metrics continue to deteriorate through the fourth quarter as our customers reduced headcount and closed locations. This deterioration caused our revenue results to be toward the low end of our fiscal 2008 revenue guidance. On a positive note, new business results continue to be in line with our expectations. Despite the difficult economic environment we continue to have success in expanding our customer base as we demonstrate the value of our products and services.

In addition to offset increased fuel prices, we were able to obtain some price increases from our customers during the second half of the year. However we continue to experience very competitive pricing pressure within our customer base, most notably as contracts reach renewal. Our uniform direct sales operating segment incorporates our national accounts sales division which direct sells uniforms, brand and promotional products and other related products to national and large regional customers and our direct sale catalogue which direct sells uniforms and related products primarily to local customers who also rent products from us.

The uniform direct sales segment grew 6.7% for the fourth quarter on a work day adjusted basis. Organic growth for the fourth quarter was also 6.7%. This growth represented a significant improvement from the third quarter when uniform direct sales growth was actually a negative 0.7%. The revenue improvement in the fourth quarter brought uniform direct sales revenue growth for the year to 3.2% for both total and organic growth.

The fourth quarter revenue improvement was in both national account division sales and in our direct sale catalogue with both achieving similar growth percentage results. As we have mentioned in the past our direct sale business is a choppier business then our other services which have a more regular delivery cycle and buying pattern. Customers within the direct sale business have the ability to accelerate or delay purchases based on economic conditions. Through the current difficult economic environment we have done a good job in retaining these customers and being flexible to their needs.

As we mentioned in a recent press release our national account sales division is beginning to focus more on international opportunities. In the past we have assisted certain global customers in their opening of certain hotels and cruise lines around the world. As more and more of our customers expand operations internationally the opportunity for the international expansion of our direct sale business has grown. Given our size and global sourcing capabilities we are now in a position to provide support to these current customers in strategic international markets and to expand our customer base in those markets as well.

In conjunction with this expansion we have changed the name of our national accounts sales division to global accounts and strategic markets. While we believe there are significant long-term uniform direct sale international opportunities the short-term expected revenues and the initial investment required to drive those revenues are not yet material to Cintas in total.

Our third operating segment is first aid, safety and fire protection services, in this business we sell and deliver first aid, safety products and automatic defibrillators to our customers. We also provide safety training to their employees. Within fire protection we install, inspect, repair and recharge portable fire extinguishers and sprinkler systems. We also provide and service emergency lighting systems and kitchen fire suppression systems.

We are the largest on-site provider of first aid and safety products in North America and the second largest provider of fire protection services. During the quarter revenues within our first aid, safety and fire protection services operating segment grew 6.7% when adjusted for work days. On an organic basis this segment grew 5.3% which was the same as third quarter internal growth. As with our other businesses general economic conditions continue to cause a headwind in this business.

For the year first aid, safety and fire grew 11.4% in total and 6.1% on an organic basis. The first aid and safety portion of this segment provided double-digit organic growth for the year however our fire protection business suffered throughout the year due to pressure on fire installation sales, lower then anticipated recurring service revenue and difficult year-over-year comparables. Overall our fourth quarter revenue results in this division were comparable to those of our third quarter.

We continue to evaluate and make strategic acquisitions within this operating segment with a focus on expanding the geographic coverage of our fire protection service business in order to become a national provider of this service.

Our document management services operating segment is comprised mainly of document shredding services although we do have storage and imaging capabilities. Revenues within this operating segment continue to grow at a rapid rate. Fourth quarter revenues for the document management operating segment grew 53.8% as compared to 71.2% in the third quarter on a comparable work day basis. Internal growth for the segment was 30% down from approximately 40% in the third quarter.

As mentioned in prior earnings calls organic growth over the past year has been positively impacted by increased shredded paper prices which began to climb in January of 2007. The price of recycled paper stabilized over the last few months which caused a slowing in our fourth quarter organic growth rate. Excluding the effect of paper prices our shredding business grew approximately 30% during fiscal 2008 on an organic basis.

Despite current general economic conditions and the size of our shredding business we expect to continue to grow over 20% on an organic basis excluding any effect from paper prices. In addition, we service customers in over 85 of the top 100 markets in the United States and Canada and have become a national provider of this service. We continue to focus on acquisitions within this segment in order to gain access to the remaining large markets and also to supplement existing operations.

We continue to be pleased with the results of our document management business in The Netherlands. While small it is meeting our expectations and we are gaining valuable experience in running this international business. Over the last 10 years Cintas has undergone significant change transforming from predominantly a uniform rental company to a full fledged business services conglomerate.

Ten years ago total company revenue was less then $1 billion and approximately 70% of that revenue was from uniform rental. For fiscal 2008 our revenue breakdown was as follows: uniform rental is 39%; dust control which is mainly entrance mats is 15%; restroom supply and cleaning is 7%; shop towels are 5%; linen which is not tablecloths and bed sheets but rather is mainly garments such as lab coats and aprons is 6%; this brings total uniform rental and ancillary products to 72% of total company revenues; uniform direct sales 13%; first aid, safety and fire protection services is 10% and document management is 5%.

As you can see uniform rental is now only 39% of our total revenue and uniforms in total, with rental and direct sales are only 52% of our $3.9 billion of revenue. In fact today over 50% of our customers do not rent or buy uniforms from us. We expect this trend to continue as our emerging businesses grow at a faster rate then our uniform business. We will continue to evaluate and implement new business products and services when appropriate financial and strategic parameters are met and also to create the foundation for international expansion.

Fourth quarter total company gross margin was 42.9%, the same as last year’s fourth quarter and an 80 basis point improvement over this year’s third quarter total company gross margin. The total fiscal year 2008 company gross margin of 42.7% was the same as that for fiscal 2007. Gross margin improvement in uniform direct sales and first aid, safety and fire throughout the year overcame margin pressure caused predominantly by increased energy costs.

Energy costs reached a historical high hitting 4% of revenue for the fourth quarter. This was a 60 basis point increase over the fourth quarter of last year and a 30 basis point increase from the third quarter. Traditionally energy costs would remain flat or decrease from the third to the fourth quarter due to lower consumption levels as we move out of the winter months. This significant increase in energy pricing did not allow this to happen in this year’s fourth quarter.

Our rental gross margins were 43.9% of revenue for the fourth quarter, an 80 basis point decline from the fourth quarter of fiscal 2007 but a 50 basis point improvement over this year’s third quarter. The 80 basis point margin decrease from the prior year was predominantly a result of the 70 basis point increase in energy costs over last year’s fourth quarter. Our cost of hangers has also increased as a result of large commodity cost increases.

Rental gross margin improved 50 basis points from the third quarter despite rental division energy costs increasing 50 basis points. Leveraging of service and delivery labor, improvements in sourcing and logistics costs and the flow through benefit of price increases were the main drivers of this margin improvement. Other services gross margin improved to 40.5%, a 200 basis point improvement over the fourth quarter of last year and a 160 basis point improvement over the third quarter. Other services margins continue to improve as the higher margin first aid and safety and document management businesses becomes a larger portion of the base.

Additionally despite increased energy costs both of these businesses continue to better leverage their cost structures as they gain scale. During the fourth quarter a combination of sales mix and improved revenue generation in uniform direct sale also drove margins higher covering more fixed costs.

Selling and administrative expenses were 27.7% of revenue, an increase of 90 basis points over last year’s fourth quarter but a 30 basis point improvement over this year’s third quarter. During the fourth quarter of last year we exited a forward starting swap that we have put in place in anticipation of a debt refinancing for a new issuance of debt with a 30 year maturity. When the decision was made during last year’s fourth quarter to refinance this debt through the issuance of commercial paper the swap was terminated and a credit of $6.2 million or 65 basis points was made to administrative expense.

Improvements in Workers’ Compensation costs in this year’s fourth quarter were offset by an increase in medical costs. Selling expense increased 30 basis points over the prior year fourth quarter reflecting the investment in the new sales organization. We have now reached the one year anniversary of the full investment and expect to see leverage in selling costs on a [perspective] basis. The 30 basis point improvement from the third quarter was due mainly to an improvement in administrative labor as we aggressively managed our overhead cost structure and an improvement in receivable collections.

An increase in medical costs was offset by the seasonal improvement in payroll taxes as payroll taxes reset during our third quarter each year. Net interest costs this quarter of $12.1 million or 1.2% of revenue remained relatively flat as compared to both the prior year fourth quarter and this year’s third quarter. Our effective tax rate was 36.5% for the quarter and 36.8% for the year. The improvement was due to reduction in reserve requirements as required under FASB interpretation number 48, accounting for uncertainty in income taxes, an interpretation of FASB statement number 109 or more commonly called FIN 48.

For the quarter net income was $89.7 million and earnings per diluted share was $0.58 reflecting operational improvements and the impact of share purchases made earlier in the fiscal year. Our balance sheet continues to be strong. Our current ratio is 3.5 to 1 at May 31st and our equity has improved to a record $2.3 billion. Our cash increased $31 million from May 31st, 2007. The majority of this increase is due to a balance sheet reclassification we made during the current quarter. In the past we have netted outstanding checks against daily cash holdings at our depository bank.

Due to a transfer of certain cash holdings to another bank we no longer have a complete right of offset within cash and cash equivalents on our balance sheet as the cash and the outstanding checks are with different depository institutions. This reclassification increased cash and cash equivalents on the balance sheet by approximately $28 million and likewise increased accounts payable $28 million for the outstanding checks.

When adjusted for this amount cash and marketable securities in total increased $8 million. Cash generated in excess of daily needs is used to pay down outstanding commercial paper. Our marketable securities are all held in Canada. These funds which were generated from operations there are held in short-term conservative government investments and are currently being held for investment opportunities outside of the United States.

DSOs on accounts receivable were 41 days which is a slight increase over last year. We are actively managing our accounts receivable in order to lessen any potential impact from current economic conditions. New goods inventory levels increased $7 million over May 31st, 2007. The increase is due to a combination of increased inventory requirements for the rollout of our direct sale catalogue and the opening of a new facility services distribution center. This new facility has been designed to improve logistics and enhance the cost structure of our facility services business.

Long-term debt at May 31, 2008 was $944 million. Total debt as a percentage of total book capitalization was 29.5%. Our cash flow remains strong with cash provided by operations totaling $545 million and free cash flow of $354 million. Capital expenditures are $190 million for the year of which $141 million was invested in our rental division; $31 million was invested in document management, $12 million in first aid, safety and fire and $6 million in uniform direct sales.

Approximately 30% of our CapEx is considered maintenance CapEx. For next year, fiscal 2009 we expect capital expenditures to be between $180 million and $200 million. In fiscal 2008 we spent $112 million on strategic acquisitions, mainly of first aid, safety and fire protection services and document management businesses. Historically during more difficult economic environments acquisition opportunities have increased. Our current pipeline is healthy and we have maintained our liquidity in order to be flexible if opportunities arise.

We did not purchase any shares under our share buyback program during the fourth quarter, as we continue to balance purchases with cash flow generation and usage. Given the current economic environment and potential acquisition opportunities we have been maintaining liquidity and debt capacity or dry powder. For the year we purchased 5.2 million shares of stock. Since the program’s inception we have bought back 19.4 million shares. We continue to have $228 million in remaining authorization under the existing program.

During the fourth quarter we paid a $71 million annual dividend that we announced and accrued during the third quarter. This represented an 18% increase in our dividend and demonstrated our continued commitment to our shareholders. This is our 25th consecutive year of increasing our annual dividend payment which is every year we have been public. As mentioned by William, and in our earnings release our guidance for fiscal 2009 calls for revenue to be between $4.1 billion and $4.2 billion and earnings per diluted share to between $2.22 and $2.30.

We expect earnings to improve as we progress through the year as we gain additional selling cost leverage and receive the impact of recent cost containment initiatives. Also please note that for fiscal 2009 there is one less work day in the first quarter and for the total fiscal year. Also included in this guidance is our expectation that our effective tax rate will be approximately 37.1% for fiscal 2009. Please note that as required under FIN 48 income tax reserve requirements will vary quarter to quarter.

We expect our effective tax rate to be higher in our first and second quarters and then come back in line during the third quarter mainly due to the timing of state and federal tax reserve requirements. Thank you and now William and I will be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Kartik Mehta - FTN Midwest Research

Kartik Mehta - FTN Midwest Research

I wanted to get your thoughts on the organic growth assumptions you have for the uniform business for FY09, would you anticipate that it’ll range the same as it was in fourth quarter or would you anticipate any type of changes for FY09?

William Gale

We would anticipate right now based on our plan and our view of the economy that it will improve slightly but not significantly over what we experienced in the latter half of 2008.

Kartik Mehta - FTN Midwest Research

What about energy costs, obviously it seems as though energy costs have increased at least in this quarter, did your guidance assume energy costs stay stable or are you anticipating an increase there as well?

William Gale

The guidance that we provided assumes that energy costs that we’ve experienced pretty much in the latter part of May and June will remain at that level throughout fiscal 2009.

Kartik Mehta - FTN Midwest Research

As you maybe look longer term, maybe over the next couple of years, is the uniform business in your opinion, can it get back to high single-digit organic growth or are we in a situation where you think organic growth is more mid single-digits?

William Gale

At this point I still am of the belief and I think our management is here too that ultimately it can get back up to the high single-digits however in the short run I think the mid single-digit growth is probably what we’re going expect. We’re continuing to see the impact on our traditional uniform rental customers being relatively significant and our people don’t see that changing at all for the next nine to 12 months. As a result of that I think the guidance that we gave you assumes that we will achieve somewhere in the mid single-digit growth in the rental business as we go forward but we still believe on our strategic plan basis that as we look out the next few years that we can get back up to the high single-digits without any question.

Kartik Mehta - FTN Midwest Research

I want to know if you could maybe talk about trends you witnessed during the quarter, and maybe just from a big picture standpoint what you witnessed the first two months of this quarter, do you believe that things are improving, staying the same or deteriorating from an overall economic picture for the business?

William Gale

Looking at our customers we saw a deterioration—we saw deterioration beginning last November but it accelerated I would say as we moved through our fourth quarter which ended May 31 and has kind of remained at that level throughout the first six weeks of this fiscal year. I don’t think it’s gotten significantly worse but it hasn’t gotten any better in primarily the garment business. Now on the other hand I would tell you that our emerging businesses still seem to be performing very well and we haven’t really seen any deterioration there to speak of.

Operator

Your next question comes from the line of Andrea Wirth – Robert W. Baird

Andrea Wirth – Robert W. Baird

If you could maybe just talk a little bit about just your view of the cycle in general, it sounds like things did deteriorate throughout the quarter, maybe at least maybe pause here, but one of your peers recently kind of mentioned that they thought just given the deterioration they were seeing that this may be approximating 2002, 2003, just curious what your views are on this current cycle and if this is looking like others we’ve seen in the past?

William Gale

I think it looks more like probably what we were seeing in the early 90s. The 2002, 2003 situation was a pretty quick down and then right back up. I don’t anticipate we’re going to go right back up. I think this is a little more prolonged and so therefore I’m anticipating that we’re going to have relatively sluggish economy throughout our fiscal 2009.

Andrea Wirth – Robert W. Baird

Just more in terms of your ability to actually maybe see some improvement in fiscal 2009 in the rental growth despite seeing some deterioration in employment markets, I guess is this just more a function of the Project One really just still gaining even more momentum or maybe kind of talk a little bit more about why you think you should be able to at least hold that growth steady and actually improve it?

William Gale

Well I think the major reason is that because of Project One Team we are seeing good new business. That has not deteriorated. As we anticipated our new business results have continued to be pretty good and actually have improved over the course of fiscal 2008. Therefore that will offset this sluggishness that we’re seeing with existing customers and that’s what gives us comfort to say that we’ll be able to grow the business next year albeit at not as high a rate as we would like it to be.

Andrea Wirth – Robert W. Baird

And then along the lines of new business just curious what you’re seeing as far as interest from no programmers or customers, who don’t have a uniform rental program at this time, is the economy impacting interest in general or is there still relatively high interest from that level?

William Gale

Its still high interest; its still very good. I think that the value proposition is even more compelling today then it has been in the past because when you can talk about the fact that we can provide this uniform rental program to an employee of a customer for basically $1.25 to $1.50 a day and these poor people are paying $4 and $5 a gallon of gas, it begins to look like a tremendous value and therefore I think that is why another reason why our new business efforts continue to be pretty strong.

Michael Thompson

Also when you look at that it eliminates an initial investment on their part, they’re going to purchase uniforms up front versus a rental program. They have a significantly higher investment day one and if they’re having difficulties with cash flow certainly a rental program is advantageous to them.

Andrea Wirth – Robert W. Baird

In terms of energy I wonder if you could be more specific about what you did actually roll through in terms of it is actual price increases, a surcharge, and have you really kind of already seen the benefit of that or is there still more to come in the next quarter or two from the recent actions?

William Gale

As you may recall the way we handle our price increases in the rental business are primarily on the anniversary dates of the contracts. We don’t have a specific energy charge so what we’re doing is as those contract prices come up for the opportunity to increase prices, we’re going to our customers and doing that because of the significant increase in costs that we have had. So that’s the rental business. In the other businesses such as document management, first aid and safety, we’re going in as opportunities arise to offset our cost increases in energy with price increases in those particular businesses. I think you’re going to continue to see some price increases rolling through just the way the nature of our businesses work and how contracts come up and obviously if energy costs would stabilize we would begin to see a little bit of margin enhancement on that.

Andrea Wirth – Robert W. Baird

I think you had mentioned particularly on renewals was where you were seeing increased competition in terms of pricing, I was just wondering if you can kind of address the difference there because I guess are your peers also doing some energy things in terms of pricing or I guess just trying to understand the contradiction there.

William Gale

Well what’s happening is we’re seeing our competition be very aggressive at the end of our contracts to basically get our customers business. So they’re coming in at very low prices and we’re going to have to beat that competition at these contract renewals. What they’re doing with energy I don’t really know because it seems to be somewhat different in different parts of the country so I don’t know if they have a consistent approach or not. But they certainly are being especially the big players, are being very, very aggressive and offering extremely low prices in order to get business.

Andrea Wirth – Robert W. Baird

And then document shredding, the margin very impressive there this quarter, just wondering if there’s anything in there making it a little bit higher then normal and essentially is this rate sustainable?

William Gale

Well it is sustainable as long as paper prices remain at these levels. As Michael mentioned in his comments we began to see an increase in the value of recycled paper back in January of 2007 and it really peeked probably around December, 2007 January, 2008, now it’s moderated a little bit but expectations are that it will probably stay at these levels. So unless there’s a dramatic fall off these margins are fairly sustainable.

Operator

Your next question comes from the line of Ashwin Shirvaikar – Citigroup

Ashwin Shirvaikar – Citigroup

You had a pretty good cash flow performance this quarter and could you go through again in terms of using your free debt capacity if you will, the order in which you would take a look at share buyback, international expansion, acquisition opportunities and other things you might be doing.

William Gale

Well I don’t think I can tell you how they rate, obviously we factor all of those together as we looked at the availability of cash and what our debt capacity is, acquisitions aren’t just looming out there, they come sporadically. We’ll just take an approach to look at our cash on a continual basis, look at our opportunities and put the money where we feel we can get the best return long-term for our shareholders.

Ashwin Shirvaikar – Citigroup

It just sort of seems odd that you wouldn’t be doing a buyback at $25, $26 a share.

William Gale

Well as I said, it is constantly being reviewed and we have amounts remaining under the program but we’ll continue to keep you updated on a quarterly basis as to what we’re going to do.

Ashwin Shirvaikar – Citigroup

In terms of the quarterly performance the stock compensation seemed to be a fairly low number in the quarter, is there anything worth noting there?

William Gale

Not really, you always have to kind of adjust your assumptions as you go forward but there’s nothing unusual.

Ashwin Shirvaikar – Citigroup

In terms of the first aid business, the fire protection side of it, are the problems there behind you getting better, any update on what the strategic ideas you’re looking at might be?

Michael Thompson

Certainly we are now a year out now from the difficulties with the year-over-year comparisons and that we’ve been a year out, that business is still suffering a little bit from the installation side but certainly we believe at least from a comparable standpoint it’ll be a little easier to see next year. The fire protection business we continue to look at the service and focus on the service side of the business versus the installation side, so we’re still going through some changes within that division to ensure that we’re focusing on the recurring revenue stream. That is what we’ve always wanted to begin with and so we expect improvement going forward.

Ashwin Shirvaikar – Citigroup

In terms of the operating margin that you expect a range that you expect for fiscal 2009, would you say that there’s enough going on in terms of cost control and things of that nature that you can offset any pressure you might have on the gross margin side because of higher fuel and so on?

William Gale

Well I think as we pointed out our assumptions right now are that fuel costs will remain at these levels that we’ve seen over the last six to eight weeks. Obviously if fuel prices doubled that would be a very difficult thing for us to overcome. But we don’t expect that at this point. So I would say that as long as its modest we probably can overcome it but the more substantial it becomes the more difficult it is to do anything in the short run but I think its important to keep in mind that fuel prices could go down too. There could be an opportunity for us especially in light of all the things that I think we have undertaken to improve margins in other areas that we may see an improvement in the margins.

Michael Thompson

We certainly believe that the cost containment initiatives we’ve put in place over the last couple of quarters will certainly provide us some additional leverage going forward, certainly difficult to predict fuel prices though.

Ashwin Shirvaikar – Citigroup

But in terms of just looking at the margin expectation, assuming things stay roughly where they are do you think that operating margins can come in flat to slightly better?

William Gale

Yes.

Operator

Your next question comes from the line of Scott Schneeberger – Oppenheimer

Scott Schneeberger – Oppenheimer

Following up on an earlier question as far as new programmers what category verticals are you seeing that in, just looking for the areas of strength now that you’re pursuing?

William Gale

Well we’re pursuing it primarily in the service sector. We’re looking at opportunities in any companies that have their employees in the public view be it a retail environment, be it delivery, home repair or things of that nature. So that’s our primary focus at this time trying to take advantage of where the economy is at least stable or growing.

Scott Schneeberger – Oppenheimer

I assume usual or obvious suspects where you’re seeing deterioration and lost business or ad stop, any verticals or categories that would surprise us there?

William Gale

No I don’t think anything would surprise you, it tends to be the manufacturing environment, the big distribution type environment that service the manufacturing operations. We’ve seen deterioration in the restaurant and hospitality business and that’s impacted some of our facility services business because there have been more failures there. That may be the only thing that maybe you wouldn’t have picked up on.

Scott Schneeberger – Oppenheimer

Sounds like you’re hopeful that we get some improving comparisons on energy going forward, any updated thoughts on hedging or hedging strategy going forward?

William Gale

We continue to look at it. At this point in time we really don’t anticipate that it’s anything we’re going to go into in any big way/

Scott Schneeberger – Oppenheimer

You’ve been in press release recently about looking at going into a global operations, global accounts, thoughts on that, building or buying and it looks like you’re looking at very disparit parts of the world to approach, could you just give us a little bit more about the strategic approach there?

William Gale

First of all I think everyone needs to understand that we have always done a little bit of international, it’s been on a very minor basis. But for example, one of our big customers, very high end hotel has utilized us throughout the world as they opened up a new facility in Asia or South America, wherever and we’ve often gone with them and put uniforms on all their people there. I think when the last big ship that was built in England, The Queen Mary, cruised out a few years ago from London; we were the ones who basically provided all the uniforms for those workers on that ship. So we’ve always been doing that.

Now I think the thing that we are ready and prepared to do is to respond to many of our customers’ requests that have been big customers of ours here in North America, people like Marriott, Starwood, Hilton, etc., who are being very aggressive and building facilities outside of North America and have asked us to help them with their uniform needs. We now feel we are capable of doing that and so that is the main focus that we have with this international expansion. The other aspect of that would be in terms of the gaming industry. In Macau there has been a significant build up of casino business in Macau, I guess they now even surpass Las Vegas in gambling revenue. And many of the big players there are major customers in Las Vegas so they’ve asked us to come over there and we are going to help them do that.

The other aspect of our international is what we’ve talked about throughout this year and that is the document management business. In Europe we see a lot of opportunities there. We did buy the company last year. We have learned that business. We are now looking at additional acquisitions and we see that coming about assuming we can get things for the right price here over the course of the next 12 to 24 months. Those couple of things that I just mentioned are the main focus of international. It doesn’t require a lot investment. It doesn’t require a significant amount of people but it is going to enhance our presence throughout the world for customers that we’ve been servicing here in North America for many years.

Scott Schneeberger – Oppenheimer

Understanding the global expansion with the existing customers probably does not require extensive further investment but perhaps the acquisition strategy in Europe, would that be sizable? Is it going to be piecemeal here or there or are there sizable targets that you’re pursuing?

William Gale

As far as I can tell in Europe the targets that we would be looking at are relatively small. There are no significant sizable opportunities that we would be interested in Europe in document management at this time.

Operator

Your next question comes from the line of Michel Morin - Merrill Lynch

Michel Morin - Merrill Lynch

Specifically during the quarter did the ad stop in lost business metrics worsen during the quarter?

Michael Thompson

Yes.

Michel Morin - Merrill Lynch

On the direct sales front, was there anything unusual that either impacted the top line or the gross margins there?

Michael Thompson

Well the top line certainly was the driver of the gross margin, as you cover more of your fixed cost in that business your margins move up quite a bit. From a top line perspective some of it was a little bit of timing and just with the customers in that business you’re consistently in front of them, you’re consistently selling to them. As we indicated it can be a little spottier of a business in that it can go up and down quarter to quarter. Obviously we were a little lower in Q3 but made it up in Q4. Again that business is a little harder to indicate on a quarter to quarter basis up front.

Michel Morin - Merrill Lynch

And in terms of thinking out to 2009 the gross margin level for the full year is probably the better metric to look at in terms of possibility?

Michael Thompson

Yes.

Michel Morin - Merrill Lynch

Could you remind us on the SG&A front what the cost containment initiatives are and what your expectations are there?

William Gale

Well cost containment encompasses a lot of things, we are looking at every administrative expense that we incur in the company and trying to determine is it necessary, is it something that we have to do, and can we do it more efficiently? And that involves people as well as travel, supplies, housing, etc. So that’s where our major focus has been. We want to free up as much as we can to increase the top line. Put it into sales and marketing type efforts that will have a return. Looking at MIS or IT projects that could generate a return down the road. So those are the types of things we’re looking at but it just goes back to the [Spartan] approach that Cintas has always tried to follow is look at every cost and make sure that it is necessary and that it is something that’s going to have some value going forward.

Michel Morin - Merrill Lynch

For the last few years your SG&A line has grown pretty consistently faster then the top line, should we, based on what you’re saying, should we anticipate that maybe in fiscal 2009 that they’re going to grow at the same rate perhaps or even maybe you’ll get some leverage on that SG&A?

William Gale

Well actually they’ve grown over this period of time primarily from the S side because of P1T, and some of the regulatory costs that we’ve had associated with stock option expensing, with restricted stock, with the union campaign, with other legal fights. And so barring anything unusual, we know we’re getting leverage now on the Project One Team on the sales side, we’ll continue to show improvement on the G&A side so when you factor out all these additional costs that public companies have had to contend with and that Cintas has had to contend with because of the union fight, I actually think its been quite remarkable that we haven’t had even a higher increase.

So as we look forward we don’t have any, hopefully, any of those additional regulatory costs but we’ll have to see what happens, but we certainly should get leverage because we’ll continue to grow that top line.

Michel Morin - Merrill Lynch

Included in that SG&A you’ve got bad debt I assume in there is that something you’ve seen starting to tick up at all?

William Gale

Well as Michael mentioned our DSOs ticked up slightly but our actual bad debt expense declined slightly so we’re seeing a little slower paying but I don’t think we’re seeing any significant increase in the number of actual write-offs that we’re having to incur.

Michael Thompson

Write-offs were up just a little bit for the year not dramatic, so I’d agree with William, nothing significant there.

Operator

Your next question comes from the line of Gary Bisbee - Lehman Brothers

Gary Bisbee - Lehman Brothers

You mentioned a couple of times that new business is sort of inline with plan and may have gotten a little bit better throughout the year as you’re getting further and further away from the sales [inaudible] can you give us any better sense then that, quantify it or how much has it accelerated?

William Gale

Well we really don’t want to get into that level of detail but it has improved modestly as we went throughout the year and it is pretty much at our expected levels.

Gary Bisbee - Lehman Brothers

Back in the day that used to be sort of mid teens, I take it--

William Gale

Its still double-digits, I don’t want to get in to the specifics but its double-digits.

Gary Bisbee - Lehman Brothers

Is a lot of that coming from headcount, the headcount additions you’ve done or are you now further enough into it that you can say that the productivity on a per sales guy basis has actually begun to improve as well?

Michael Thompson

It’s actually on a per sale rep basis because the headcount that we added was on the management side in that initial investment in the selling organization. It is in productivity and certainly you continue to add reps in the emerging businesses the one thing that this new organization gave us across the board was the opportunity to more aggressively add reps in our emerging businesses to take some opportunities in the new markets we’re entering and adding where appropriate based on the market.

Gary Bisbee - Lehman Brothers

One of the things you talked about just going back to the Project One Team initiative a year ago was hopefully beginning to drive some more cross sell, is that working, are the sales people feeling like you set up the comp policy right, so that they get a referral that’s meaningful to them, any update on how that’s going and maybe what else is driving the productivity improvement?

William Gale

It’s working very well with regard to the emerging businesses because it’s now giving the sales people in the emerging businesses this huge customer list of Cintas customers. And I would say that its working to a lesser extent though as you go to our traditional uniform rental customers and try to convince them to use some of these other services, they may or may not need them, but there have been some wins and I would say we continue to tweak our compensation programs to make sure we’re getting the behavior that we want and I think that that is just a learning thing as we go through. But yes, we’re pleased with what we’re seeing there.

Gary Bisbee - Lehman Brothers

You said I think in the prepared remarks that the marketable securities are largely in Canada and you’re keeping it there essentially for international acquisitions, I guess you commented that you didn’t see anything big in Europe, should we be thinking about anywhere else that there might be more medium or larger sized deals or is it going to be more of the same of what you’ve been doing over the last 18 months?

William Gale

I think we recognize that to just bring cash back into the United States from Canada is a very expensive thing so we’re looking at opportunities for using that cash for not just acquisitions but also capital type investments as we see the opportunities in various parts of the world.

Michael Thompson

To bring back that cash to the United States is a taxable event so it’s been building up there with operations since we started investing in Canada. We’ve now obviously got over $100 million in Canada that we feel we can use for international opportunities and now with the move in both direct sale and also what we’re doing in document management in The Netherlands, we believe it provides us the capital without having to leverage the debt markets to do that.

Gary Bisbee - Lehman Brothers

I guess the reason I’m asking the question that way is you did $110 million or $112 million of acquisitions this year, you’ve got more then that in cash in Canada today so are we, I’m talking total company acquisitions are you likely to step up the international acquisitions or is the money likely to sit there for awhile?

William Gale

Its very difficult for us to be too specific because we have a lot of different things going on and we don’t want to necessarily show our hand yet of what we’re going to do but let’s just put it this way, that we’re going to find the right opportunities and obviously if we see the chance to make a good acquisition outside of North America that Canadian cash is going to come in very handy in order to do that.

Michael Thompson

Or if we find that the right opportunity to make an investment not necessarily and acquisition, but to start up either adding some more infrastructure for our direct sale or expanding document management or something else internationally, those funds are available to do that. It could be a combination of the two.

Gary Bisbee - Lehman Brothers

In terms of the document management business it sounds like you’re in most of the major markets although I still don’t think I’ve seen a truck in New York anywhere but you’re in most of the major markets, how much investment is left to sort of build out the route densities and get more trucks into each market, I guess I’m just trying to understand how that $30 million of CapEx, is that a number that has to keep growing presumably for several years as you keep investing in the business or are we getting to a point where you’ve got reasonably good coverage?

William Gale

Well I think we’ve got a lot of opportunities, even though we may be in 85 of the top 100 markets, doesn’t mean we’re doing as much business as the potential that exists there. So what we would anticipate is that yes, the $30 million expenditure is probably going to grow over time because we’re going to continue to see that revenue go up quite substantially and you’ve got to have the truck to do the revenue—in order to generate the revenue so we anticipate that that business is going to continue to grow at very nice rates. And in order to support that growth obviously we’re going to have to invest the capital in it and therefore it will go up proportionately.

Gary Bisbee - Lehman Brothers

Was there any major impact we should expect from the fire that we’ve read about that happened recently in one of your facilities or is that--?

William Gale

No there will be no major impact at all. One of the real advantages Cintas has is because of our geographic coverage we were able to shift the business for those customers very quickly into some of our other adjacent facilities and we were able to get uniforms out of our distribution centers that were destroyed in that fire. Obviously there’s adequate insurance coverage for the physical assets. Our customers did not miss a delivery. So it just shows another good reason that customers do business with us because we’re able to react so quickly when we have a problem like that.

Operator

Your next question comes from the line of Brandt Sakakeeny - Deutsche Bank

Brandt Sakakeeny - Deutsche Bank

On the tax rate, I think you said the first half was higher then the second half, should we assume something like 38% for the first half and maybe 36% for the second half?

Michael Thompson

We expect it to be 37.1% next year for the year, it will be a little higher, I don’t want to get into specifics but certainly I would trend it higher in those ranges for Q1 and Q2 it’ll take—as long as the reserve requirements under FIN 48 remain consistent with where they were this year, you’d see the correction come in Q3 fairly substantially to bring it back down in line at that point in time.

Brandt Sakakeeny - Deutsche Bank

The extra day that you had in FY08 did that fall in the fourth quarter?

William Gale

It actually fell in the—it was actually in the fourth quarter and then--

Michael Thompson

The extra day was in Q3 but then we were one short in Q4. It was the same number of work days for the year.

Brandt Sakakeeny - Deutsche Bank

So FY09 will have one fewer work day.

William Gale

And that will be in the first quarter.

Brandt Sakakeeny - Deutsche Bank

So then the 3 8 to 3 6 sequential drop, that’s on a same day basis or does that adjust for the differential in the days?

Michael Thompson

That adjusts for work days.

Brandt Sakakeeny - Deutsche Bank

Back to the question around margins and the new business growth, I just remember back in 2002, 2003 Karen was always talking about the fact that new business growth was more expensive relative to renewal growth and that in periods where you saw accelerating new business trends, you often saw margin compression. (a) Do I remember that right and (b) as we look out to FY09 if you do in fact assume new business acceleration your flat margin assumption, does that presume then that you’ll get the added leverage on the SG&A line to offset for that higher new business cost?

William Gale

Well first off you’re absolutely right, new business is the most expensive business as long as you continue to provide new garments for your new customers which we always do. You have all that expense of the new garments beginning amortization and you have the sales commission costs, etc. so that is the most expensive. But when we put our plans together for the coming year, we’re very detail oriented and so we are—its basically as we look at margins and new business growth etc. we have factored all that into the guidance that we provided and to the answers to the questions earlier, and so I guess to answer your question is, yes we’re going to have pressure of new business but on the other hand you’re getting additional leverage in your facilities, maybe a higher route capacity and so it balances itself out to where as I said earlier, that we could if energy costs remained constant we could see a slight improvement. So that tells you you’re getting the leverage in some of the other fixed cost areas.

Michael Thompson

And certainly based on our plan the increased revenues are not dramatic. We’re talking a lower growth rate next year.

Brandt Sakakeeny - Deutsche Bank

On the balance sheet I just want to make sure I understood, so you said that that sequential increase in the payables was due to the cash, or at least the check payables being held, the offset was the cash and equivalents, is that right on the balance sheet?

Michael Thompson

Yes, in the past you used to net the outstanding checks with depository institution because you had marketable securities and other cash balances there—at the same institution. This year because we switched institutions you don’t have the right of offset so I have the cash so I had to increase the cash balance but now I have the outstanding checks as well. So it was strictly a balance sheet reclass where instead of netting it within cash and cash equivalents and to separate it back out and increase my payables and increase my cash.

Brandt Sakakeeny - Deutsche Bank

On one other item on the balance sheet I did notice that inventories had declined, or at least grew but at a very low rate, any sort of liquidation there on inventory, is there anything else that would explain that very small increase?

Michael Thompson

No. I’d say overall better management, the dollar went up mainly because of the new facility services distribution center that we just opened up a couple of months ago, but overall I think its just better use of the existing inventory. There was no liquidation.

Operator

Your next question comes from the line of Greg Halter - Great Lakes Review

Greg Halter - Great Lakes Review

Regarding inventory, have you made any changes to the amortization schedules that you had in place since the last year or fiscal year?

William Gale

No we have not.

Greg Halter - Great Lakes Review

On the CapEx side any commentary on new plants, either you have in progress currently or expect for 2009 and the retrofits or upgrades you’re going through currently?

William Gale

We’ve got a couple of new plants that are in the construction phase. I think there’s four maybe that we would probably be opening up over the course of fiscal 2009 and that is about it from the plant side. Where we’re seeing the capital being spent is obviously in supporting the truck fleets in the document management business and then just normal maintenance type capital.

Greg Halter - Great Lakes Review

Regarding your debt, on an average basis what was the average for fiscal 2008 and I don’t know that you can comment on 2009 I guess depending on the fixed versus variable, but if you could comment where you stand on fixed versus variable currently, I would appreciate that.

Michael Thompson

We have about $163 million in commercial paper currently at May 31st, and the remainder which is about $780 million is in fixed, our current blended rate is about 5.5%.

William Gale

So what would happen is during the course of fiscal 2009 we would generate sufficient cash to pay off that commercial paper unless we became more aggressive on acquisitions or did share buybacks.

Greg Halter - Great Lakes Review

I haven’t heard much about the unite effort and just wanted to ask and see, I know they’re still out there but what you’re seeing and doing regarding that effort currently?

William Gale

Well we’re doing what we’ve continued to do is try to offset their propaganda. They have been relatively quiet. They show up at one of our facilities now and then distributing flyers. I don’t think their tactics have really changed much. The word is, I can tell you, they continue to make no progress with our partner base. We have less then 400 partners in labor unions right now. I think they’re going to focus on the political front and depending what happens in the elections in November we may see them trying to get their—what they wanted to try to accomplish through the legislatures and potentially the new administration.

Greg Halter - Great Lakes Review

I know you have suits that you detail in the Qs and Ks and so forth, any updates on any of those particular lawsuits?

William Gale

We’ll be filing our 10-K here by the end of July and I think I can pretty much tell you that you’re not going to see there’s been much changes in the developments in those cases since the Q was filed at the beginning of April.

Operator

Your final question is a follow-up from the line of Michel Morin - Merrill Lynch

Michel Morin - Merrill Lynch

You mentioned the cost of hangers; I was wondering if you could quantify that a little bit for us? It’s the first time we’ve ever heard you talk about that.

Michael Thompson

It wasn’t a dramatic increase but certainly it was enough that as you look at the increase in gross margin versus last year, the vast majority was in energy costs but there was an increase in hangers, basically the increase in commodity costs and some tariff situations caused that.

Michel Morin - Merrill Lynch

And how big of a cost is that?

Michael Thompson

I don’t have it on a percent to sale basis--

William Gale

It was like half of one percent, half of one percent, I just—the reason that we brought that up is just to give you all an indication that we’re beginning to see inflationary pressures in some of our other cost elements. There’s no big other cost elements but that’s one that’s risen fairly dramatically here in the last three to six months.

Michel Morin - Merrill Lynch

Are there any differences in trends between Canada and the US?

William Gale

I would say Canada is pretty good; their economy seems to be relatively strong. We don’t see nearly the ad stops and lost business that we’re seeing in the states. They’ve had, of course—they’ve done pretty well so it’s been a good steady business up there.

Michel Morin - Merrill Lynch

The distribution center that you opened, that was opened during the quarter?

William Gale

Right at the end of the quarter.

Michel Morin - Merrill Lynch

And were there any costs associated with that or is it mostly all capitalized?

William Gale

No there were some costs, some start up costs but they weren’t that significant in the whole scheme of things but we feel like they’re going to help improve our efficiency on distribution of our facility services products and ultimately will help lower the cost of that product in our business.

Michel Morin - Merrill Lynch

So that’s attributable to the rental segment?

William Gale

Yes, its part of the rental segment, right.

Operator

At this time we have no further questions; I’d like to turn the program back over to Mr. Gale for any additional or closing comments.

William Gale

Thank you and thank all of you for joining us. We appreciate the interest in Cintas and we look forward to talking to you in September when we discuss our first quarter fiscal 2009 results. Thanks again for joining us.

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Source: Cintas Corporation F4Q08 (Qtr End 05/31/08) Earnings Call Transcript
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