Cintas Corporation
Q3 2011 Earnings Call Transcript

Published: 23 Mar 2011

[Operator:]

Good day, everyone and welcome to the Cintas Quarterly Earnings Results Conference Call. [Operator Instructions] At this time, I'd like to turn the call over to Mr. Bill Gale, Senior Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

[William Gale:]

Good evening, and thank you for joining us to discuss our third quarter fiscal 2011 results. With me today is Mike Hansen, Cintas' Vice President and Treasurer. After some comments on the quarter's results, we will open the call to questions. For the quarter ending February 28, 2011, total revenue was $938 million, an 8.8% increase from the third quarter of fiscal 2010. Earnings per share were $0.41 versus $0.32 a year ago. As provided in our press release, we are updating our guidance for the fiscal year ending May 31, 2011. We now expect total revenues to be between $3.75 billion and $3.77 billion, and our total earnings per share to be in the range of $1.60 to $1.63. This guidance takes into consideration our expectation that energy costs will pressure margins in our fourth quarter. We will not be providing guidance for our fiscal year ending May 31, 2012, until we release our fourth quarter 2011 results in mid-July. We are pleased to see continuing improvement in our revenues among all four of our reportable segments. As mentioned in our release, we ramped up the investment in our sales force in last year's third quarter because we saw signs of stabilization in the U.S. economy. We also expected a slow employment recovery. And we wanted to create revenue momentum by not only increasing our sales force, but also by having the sales force focus on added penetration at existing customers. As we look one year later, we are pleased with the momentum created and with the improvement in our sales productivity. This improved sales productivity, coupled with the stabilization of the economy, have now given Cintas four consecutive quarters of increasing total and organic revenue growth beginning with our fiscal 2010 fourth quarter. While we continue to see a general reluctance on the part of our customers to add employees, on a positive note, they continue to replace employees and large force -- workforce reductions are minimal. The higher revenue levels, along with ongoing cost control efforts at Cintas, have helped drive margin improvement despite the higher energy costs and the fewer workdays in our third quarter than the prior two quarters this fiscal year. These recent energy cost increases, if they continue, will pressure margins going forward. While not significantly affecting this fiscal year, continued elevated cotton costs could impact fiscal year 2012 results. We will discuss this impact further during our discussion of fiscal 2012 guidance in July. Our balance sheet remains strong. Total net debt to capitalization is 25%. In December, we paid our annual dividend of $0.49 per share, the 28th consecutive year in which the dividend was increased dating back to 1983, the year we went public. The Private Securities Litigation Reform Act of 1995 provides the safe harbor from civil litigation for forward-looking statements. This conference call contains forward-looking statements that reflect the company's current views as to future events and financial performance. These forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those we may discuss. I refer you to the discussion on these points contained in our most recent filings with the SEC. I will now turn the call over to Mike Hansen.

[Michael Hansen:]

Thank you, Bill. Before discussing the quarter in more detail, please note that our fiscal 2011 workdays are the same as last year. That means there were 64 in the third quarter and there will be 66 in the fourth quarter. As a planning note for fiscal 2012, our workdays will be as follows

[Operator:]

[Operator Instructions] And we'll go first to Andrew Wittman with Baird.

[Andrew Wittmann:]

I just wanted to just get a little clarity on some of the assumptions behind the guidance. Looks like the midpoint's about a 5% -- 5.5-maybe-percent organic growth rate, which would be about consistent with what we saw in the third quarter. Does that seem about right to you?

[William Gale:]

Well, it seems about right. Here's our concern, and I would say we expected some of you to think maybe we were a little conservative on this. But our concern is in the energy cost arena, not only how it impacts our margins but how it might impact our customers. So we are forecasting continued growth on the top line. But given the uncertainty in the energy markets, as well as in the other issues going on around the world, we felt it prudent to be somewhat conservative in our view of the revenue.

[Andrew Wittmann:]

I see. And just in terms of the margins, thanks for the clarity. It sounds like you are anywhere between 3.4% and 3%, and as high as 3.6%, I guess. Given that, I mean, today, where are we on that spectrum? Are we still kind of 40 basis points over the first two quarters at that 3.4% level? I just want to try to get a handle of what that -- what you're implying on that.

[William Gale:]

We're running at that 3.5% to 3.7% level right now. And if you think about the way that the energy impacts as we did some calculations and basically for every 50 basis points of energy costs, that's about $0.02 a share for us. So we're projecting energy costs will, at best, stay at these elevated levels, but likely could go even higher depending on what happens.

[Andrew Wittmann:]

Okay, great. And then just in terms of the operating environment, it sounded -- last quarter, it sounds like pretty similar to this quarter in terms of add/stops at existing customers. Is that fair? And is it also fair to assume then that it's still what you call the, I guess, new storefronts, new customers and further penetration in existing customers that's really driving that organic growth?

[William Gale:]

That's primarily correct, a little bit better results in lost business too, Andy. But, yes, basically, we're seeing new business continuing to be pretty good. And fortunately, customers when they lose employees are replacing those employees. So they're just not -- there's not a lot of adds or additions to our customers' headcounts.

[Operator:]

And we'll go next to Andrew Steinerman with JPMorgan.

[Andrew Steinerman:]

Given the commodity changes that are going on here and your end customer must be sensitive to them as well, have you considered a fuel surcharge currently? And would you consider a cotton surcharge to your customers prospectively?

[William Gale:]

Andrew, we don't really have a fuel surcharge per se. We have a service charge. And we have been adjusting that service charge when we can with our customers to try to overcome some of these additional costs. Sometimes, that is not feasible, but we're doing our best to do that.

[Andrew Steinerman:]

Right. But do you feel like your customers are sensitive to this matter? When you come to them and everyone knows what the price of oil is, and you're starting that discussion now with that talking point. It just seems like, hey, this is kind of a national situation. Do you feel like it's a grind to get it through? Or your customers realize that service charge, it includes higher oil prices and gas prices, should naturally ebb up?

[William Gale:]

Well, Andrew, I would say it all depends on what our customers are able to do with their prices. If they are running into difficulty in raising their prices, they're very reluctant to allow any increase in their own costs. So it really just comes down to what the individual customer is able to do in the markets that they serve.

[Andrew Steinerman:]

Okay. And the reason why cotton doesn't hit you until later in the calendar year is because you have an inventory?

[Michael Hansen:]

That's a big part of it, Andrew. When the prices of cotton started to escalate, that didn't mean that, that was going to hit us immediately. We still had a cotton fabric inventory that runs through our supply chain and goes through our distribution center before it gets to our operations. And only then do we see some impact of it. And in our Rental business, it starts to amortize at that point. So it is not a significant impact for some period of time.

[Operator:]

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

[Gary Bisbee:]

I guess a couple of questions. When you talk about, in the Rentals business, increased penetration of the customers rather than -- and I guess new customer growth rather than employment growth going up, can you give us a couple examples of what increased penetration -- I mean is that literally, I've been doing uniforms and now I'm doing floor mats, or I've been doing uniforms and floor mats, now I'm also cleaning their restrooms. What are some examples of the stuff you're penetrating?

[William Gale:]

Well, those items that you mentioned are certainly examples. In addition to that, we have a full spectrum of hygiene services for restrooms. We have chemical dispensing units. We're doing tile and carpet cleaning. So all of these different facility services businesses that we have gone into, we're able to sell those to many of our existing customers. And as Mike mentioned in his remarks, we began to utilize our professional sales force to assist our service organization in penetrating these customers with these additional products and services. And that has been successful.

[Gary Bisbee:]

Have you give -- given that it sounds like this is becoming a much more material business, have you given any thought to splitting it out within your segment results, the facility services?

[William Gale:]

Yes, we are. We are looking at that. It is difficult right now to do that on the cost side because they're housed in the same physical facility as the Uniform Rental business. There would be a lot of allocations that would have to be made and it adds a lot of complexity to our financial system. But it is certainly something that we're going to continue to look at. And when it's feasible to do so, I would say that we will start splitting that stuff out. I just don't know when that will be.

[Gary Bisbee:]

Okay, great. On the SG&A, I guess I was surprised it actually dropped by $5 million or so. You mentioned cost savings. Is there anything in particular that's been real helpful there? Or was there also any sort of one-time issues that you had -- you didn't spend on that you might expect to?

[William Gale:]

There were no one-time items. I think a lot of it is the attitude that the company management has taken that we had to control costs. And we began doing that some time ago. We did get slightly lower medical costs, which did help. But offsetting that by a much greater extent were the fact we had all the payroll taxes reset in January. I think it's the higher revenues where we're -- as I told you before, we can leverage these costs once we get the revenue line growing again. And that was demonstrated in this quarter. But it really comes down to just a lot of effort on the part of all the partners at Cintas just watching every dollar they spend.

[Michael Hansen:]

Part of that $5 million decrease you mentioned, Gary, from the second quarter to the third quarter is also just simply due to one less workday. So there's one less payroll day in the quarter.

[Gary Bisbee:]

Okay, that makes sense. And then just one last one if I could. I realize you'll laugh. I'm going back what feels like many, many years. But in Q1 of 2006, you actually gave us your energy breakdown. You said natural gas was 31%, electricity was 28%, I think diesel was -- gasoline and diesel were the rest. Can you give us a sense, is that changed a lot? Or is that still a reasonable mix to think about in terms of the different energy components?

[William Gale:]

Much of the increase in energy that we've recently seen is the gas and diesel. And the gas and diesel is about 60% of the total energy costs today.

[Gary Bisbee:]

Okay, great. That's helpful. But natural gas, which has actually been falling somewhat recently at least, is still 30% or so, is still a reasonable number for that one?

[William Gale:]

Yes.

[Operator:]

We'll go next to John Healy with Northcoast Research.

[John Healy:]

Bill, I had a question on the SG&A line for you. This is one of the first quarters in a while where we've seen revenues really accelerate beyond the SG&A line. And I was hoping to get your thoughts if we've now reached an inflection point with the company where you've increased your headcount on the sales side and you're positioned to grow. And is it safe to assume that, maybe as we head through 2012 and maybe for a bit longer, that we should see revenues accelerate at a decent clip beyond what your growth in SG&A will be for a while? Or are you guys at a point where you feel comfortable seeing that in the business?

[William Gale:]

Well, I would answer that question a cautious yes, John, assuming that there is not any unusual spikes in like medical expenses, unusual legal expenses we might run into or something like that. So those things that we can control, I would say your assumption is correct.

[John Healy:]

Okay, great. And then I wanted to ask you on the M&A front, with the business now turning quite nicely and the balance sheet being as solid as it is and the cash flow that you guys are able to produce, I mean, is there any thought of maybe becoming a little bit more aggressive with looking at larger type acquisitions either on the emerging businesses or the Uniform side? Or any thoughts about maybe beginning to use the balance sheet in ways or maybe to drive a little bit more shareholder value in terms of maybe looking at a bigger buyback or looking at a way to deploy capital a bit more aggressively?

[William Gale:]

I'd say the answer to your question is yes to all of those.

[John Healy:]

I guess from an acquisition standpoint, I mean, is there a priority right now? Are you looking at things that are more to the core Uniform side? Or would you prefer to look at things that are more on the emerging business unit side right now?

[William Gale:]

One of the priorities, we've talked about this, is certainly to obtain a national footprint in some of the emerging businesses, so that has continued. And as far as the other opportunities, we'll look at them as they present themselves and the value that they would create for the shareholders, the risk that they would involve, what type of returns that they would generate for the company. And I don't think we would necessarily be biased against anything except probably direct sale business, which we don't really see a lot of value in an acquisition for but -- because we like the more service type ongoing businesses. But we are certainly open to looking at different things, and we're doing that.

[Operator:]

We'll go next to Vance Edelson with MS SB.

[Vikram Malhorta:]

This is for Vikram in for Vance with Morgan Stanley. Just wanted to get a little more color. You mentioned sort of going into next year, cotton could be an issue. I'm just sort of wondering, could you sort of break it out between how you'd view it in the Rental business right now? Amortization could hit in next year. And how you'd think of it on the direct sales business?

[William Gale:]

We would prefer at this time to defer any real discussion on cotton until we have greater visibility with what's going to happen in the cotton market and as we put our plans together. So we'll have to defer those questions until July.

[Vikram Malhorta:]

Okay and then in terms of the -- you mentioned that you do have inventory obviously, which is why it's not hit. Could you just give us some sense of how and at what point you are in the process of replenishing?

[William Gale:]

No, we're not going to talk about that right now.

[Operator:]

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

[Scott Schneeberger:]

Just a quickie follow-up on the cotton question. Presumably, the costs remain elevated, what are some things internally you're considering? I think it was asked, surcharges, but are you considering changing the mix? Any thoughts you can give on that, just in a hypothetical, if it were to remain elevated?

[William Gale:]

Well, Scott, since so many things can happen from now until the end of the next growing season, we would rather defer those discussions until July. And we'll be a little bit more prepared to talk about the impact on next year and some of the things that we plan to do about it.

[William Gale:]

Scott, we may be working on some things that we really don't want to disclose publicly either.

[Scott Schneeberger:]

Okay, fair enough. Switching over to your sales force, it's been about a year now since you started bulking up. Could you, I guess, speak to productivity, speed of productivity? It sounds like with you're happy with what you're seeing. But just remind us how quickly new staff gets up to the level you'd like to see? What your plans are for increasing or potentially decreasing from here? And if the fact that we've anniversaried is having any impact on the cost line, as I imagine is variable, but just any thoughts there?

[William Gale:]

Well, we're very happy with the productivity. We believe our sales force and our sales management team have done an excellent job of focusing their resources in the right area and we're seeing the results in the top line. We continually evaluate the appropriate size of the sales force, and we will continue to do that as we assess what the market potential is and what opportunities are out there. So right now, I would say it's an ongoing look at things. We're not going to signal to our competitors what we're going to do with our sales force, therefore, we can't really talk about it publicly. But I think we are very pleased with what we're seeing as the results of the actions that were taken about a year ago. Keep in mind, it generally takes a salesperson somewhere between six and 12 months to achieve appropriate productivity. And obviously the more tenured they are, the typically the more productive they are. It does vary by business unit. The Rental Uniform business tends to be the longest cycle, but we do have a ramp up in all of our businesses.

[Scott Schneeberger:]

Okay, thanks. So then there is benefit now that you're hitting that maturity phase, and that's what we're seeing with regard to the leverage in the business, presumably?

[William Gale:]

That's part of it, right.

[Scott Schneeberger:]

Okay, thanks. And then just could you speak one final question on the competitive environment pricing particularly in Rental. Any change from what you've seen? My understanding, just to set what I mean is, it sounds like it is still quite competitive out there. But just any indication what you can talk about quarter-over-quarter?

[William Gale:]

Scott, I think we have seen a, I guess, a firming up of the pricing environment a little bit. I think many of our competitors have realized that some of the low prices that they were offering to help keep their plants and routes as full as they could during the downturn are going to come back to haunt them, especially now that it does that we're seeing cost increases in a number of areas. And keep in mind that cotton increases are probably going to hit our competitors much quicker and much more heavily than it necessarily will hit us. Energy costs are probably a little bit more heavier on some of our competitors than us because of the route density. So I think that we are pleased to be able to say that pricing has firmed up a bit from what it was.

[Operator:]

We'll take our next question from James Sanford with Citigroup.

[James Sanford:]

I just wanted to touch on -- I know it's still early days post-Japan. But since you have exposure to manufacturing, I'm wondering if you're starting to hear any feedback from your channel about slowdowns due to supply chain, whether it's temporary shutdowns or anything like that? Are you worried about that having an impact in your business at all?

[William Gale:]

No, we haven't see any of that, James.

[James Sanford:]

Okay. As far as buybacks are concerned, maybe I missed it, but any thoughts on how you're thinking about buybacks going forward? I know you didn't buy any this quarter. Is that sort of something you expect to put back in place next quarter?

[William Gale:]

I really can't say when that will be happening. I can tell you that the board talks about it continuously and looks at the alternatives we have, and will certainly gave us the opportunity to another authorization back at the late October. So we did $200 million just six months ago and we'll continue to assess it.

[James Sanford:]

Great. I guess one final one. I guess most recent acquisition is in the Document Management space. Is that sort of where you're concentrating some of your efforts? Should we think about that as obviously structurally lower-margin business? But as the rest of the business ramps up, should you more than offset some of that structural margin decline?

[William Gale:]

Well, James, that acquisition that was announced was more of a marketing issue. It was a relatively small acquisition. We made acquisitions in all of our businesses with the exception of Uniform Direct Sales this past quarter. The Document Management business is actually very good margin business. It's just that so much of it is in its infancy and the size and the amount of sales cost continues to be invested in it. Mature Document Management operations though generate very good margins comparable to the Rental business.

[Operator:]

We'll take our next question from Christopher McGinnis with Sidoti & Company.

[Christopher McGinnis:]

Was weather -- was there an impact of weather at all in the quarter?

[William Gale:]

I thought it would have more of an impact than it ended up having. Part of the reason that it didn't impact us as much was the fact that we've converted many of our businesses to 4-day routes. So even when operations were forced to shut down in some of the cities, especially in the northeast, they were able to make up the majority of that volume. So by and large, weather was not a significant factor to us.

[Christopher McGinnis:]

And then just on the M&A front, has anything changed in the Rental, at least in the rental market environment? I guess maybe the valuations come down at all?

[William Gale:]

No, they really haven't. I'd say the beneficial thing though is that with stabilization in the economy, potential acquisition targets aren't continuing to shrink like they were. So there's a little bit more of certainty if one were to decide to buy one of those companies.

[Christopher McGinnis:]

And I know you've answered this in the past. And I don't know if this -- I don't think the question's been posed in a few quarters. But of the large operators out there, I think you responded that you felt that you could get an FTC approval. Is that past? Do you feel that you can still do that to acquire a larger -- one of the larger operators on the Rental side?

[William Gale:]

Chris, I'd hate to predict what Washington may decide to do. Until you present the facts, it would be tough for me to speculate.

[Christopher McGinnis:]

And then just on the growth on the Rental side in the quarter itself, is there a component of taking share from some of the other players in that? Maybe even just a little bit -- I mean that was a little bit stronger than I expected. And was it more just end market demand on the services? Or could you maybe just dig into that a little bit more?

[Michael Hansen:]

Well, I will say that the Rental growth for the quarter was a pretty broad improvement. In other words, we had a garment growth. We had facility services growth throughout our different products and services. But honestly, we don't have the information this quickly to be able to tell what was no program or versus taking share.

[Operator:]

[Operator Instructions] We'll go next to Gary Bisbee with Barclays Capital.

[Gary Bisbee:]

Yes, just one quick follow-up. Have you set a sort of an IRR hurdle rate for what you're expecting to earn in the Document Management business? I just noticed that the CapEx there has been significant in relation to revenue, and I wonder how you're thinking about benchmarking that investment?

[William Gale:]

Gary, generally, as we've always said, our hurdle rates typically are 15%. Now, there will be certain acquisitions that we might accept a slightly lower hurdle rate in going into in order to do something on a strategic basis. But our review of acquisitions in Document Management are no different than they were in Uniform Rental. But they typically have to have those hurdle rates.

[Gary Bisbee:]

And what about internal investment, though, the CapEx being as high as it is, are you confident you'll earn that over time?

[William Gale:]

Oh, yes. We have the same criteria on CapEx, and, yes, that's all baked in to the analysis. Keep in mind much of what you're seeing now is the investment in these businesses to grow them, just like what we did at Cintas in the Uniform Rental business in the 1980s and early '90s.

[Gary Bisbee:]

And can you give us a sense within the Document Management, how much of this investment to date has been storage? A year ago, you were telling us you didn't really like the storage business, at least relative to just the shredding business. But I get the sense from a few press releases here and there, that might be changing. Is that fair? Is a lot of that incremental CapEx this year in storage? Or is it buying more trucks to do more?

[William Gale:]

We're still focusing primarily on the shredding side.

[Gary Bisbee:]

Okay. All right. So that would be trucks and other facilities, I guess?

[William Gale:]

Yes, as Mike mentioned, we have started up some selective storage operations in different parts of the country that we have -- we believe an opportunity to have a significant return in value. So it's not like we're -- I wouldn't characterize we don't like the storage industry. What we do is we prefer the shredding industry and then selectively look at storage locations.

[Operator:]

And with that, we have no further questions in queue. I'd like to turn it back over to Mr. Gale for any additional or closing comments.

[William Gale:]

Thank you all very much for joining us today. And as we mentioned earlier, we will be announcing our fourth quarter results in July, probably mid-July. So thank you again.

[Operator:]

That does conclude today's call. Thank you for your participation.