CTAS

Cintas Corporation (CTAS)

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Cintas (CTAS)

Q3 2013 Earnings Call

March 19, 2013 5:00 pm ET

Executives

William C. Gale - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

J. Michael Hansen - Vice President and Treasurer

Analysts

Sara Gubins - BofA Merrill Lynch, Research Division

Nathan Brochmann - William Blair & Company L.L.C., Research Division

Joe Box - KeyBanc Capital Markets Inc., Research Division

Andrew J. Wittmann - Robert W. Baird & Co. Incorporated, Research Division

James Samford - Citigroup Inc, Research Division

Andrew C. Steinerman - JP Morgan Chase & Co, Research Division

Daniel Hultberg - Oppenheimer & Co. Inc., Research Division

Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc., Research Division

Gary E. Bisbee - Barclays Capital, Research Division

Jason Rogers

Presentation

Operator

Good day, everyone, and welcome to the Cintas Quarterly Earnings Results Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Bill Gale, Senior Vice President of Finance and Chief Financial Officer. Please go ahead, sir.

William C. Gale

Thank you for joining us this evening. With me is Mike Hansen, Cintas' Vice President and Treasurer. After some commentary on the results, we will be happy to answer questions. The Private Securities Litigation Reform Act of 1995 provides a safe harbor from civil litigation for forward-looking statements. This conference call contains forward-looking statements that reflect the company's current views as to future events and financial performance. These forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those we may discuss. I refer you to the discussion on these points contained in our most recent filings with the SEC. We are pleased to report third quarter revenue of $1,076,000,000, which represents record quarterly revenue for Cintas and growth of 6.3% from last year's third quarter. Organic growth, which adjusts for the impact of acquisitions and the impact of 1 less workday compared to last year's third quarter, was 6.9%. As we noted in the press release, the organic growth in each of our 4 operating segments improved from second quarter levels. We indicated in last quarter's call that we expected our uniform direct sales segment to have a good second half of the fiscal year, and that was certainly true in our third quarter. The execution of our global accounts and strategic markets and our global supply chain teams during the third quarter was outstanding as we rolled out several large new programs on our way to over 15% growth in the uniform direct sales operating segment.

Third quarter net income decreased by 1.7% to $75 million, and there were a number of factors that contributed to this decrease. Our third quarter had 64 workdays, which is 1 less than last year's third quarter. Keep in mind that a number of our large expenses, including rental material cost, depreciation and amortization, are determined on a monthly basis instead of a workday basis, and 1 less workday results in 1 less day of revenue to cover those expenses. In addition, we have discussed on our last few calls that strong new business sales and the absence of meaningful customer hiring over the past few years have resulted in increasing rental material cost and capacity pressure on our routes. As a result, rental segment material cost exceeded last year's third quarter material cost, just as it also did in this year's second quarter. We also continue to add route capacity during this quarter to ensure that we have the ability to continue providing excellent service to our customers.

In our selling and administrative expenses, our cost associated with employee-related medical benefits increased by roughly 60 basis points compared to last year's third quarter. Keeping in mind that we are self-insured, this increase was due to new claims experienced during the quarter. Medical costs have historically been in the range of 3% to 4% of revenue, and this third quarter expense continued to be in that range. In addition to higher medical costs, our expenses associated with auto and other liability claims increased roughly 50 basis points compared to last year's third quarter. Despite these added costs during the quarter, our earnings per diluted share for the third quarter did increase over last year's third quarter. This year's earnings per diluted share were $0.60, a 3.4% increase over last year's third quarter of $0.58. This was due to the positive impact of our share buyback program.

During the third quarter, we purchased roughly $28 million of our stock, bringing our total purchases during the last 12 months to $309 million of Cintas stock. As of February 28, we have $191 million available under the current board authorization for future shares repurchases. As we enter our fourth fiscal quarter, we are updating our fiscal 2013 guidance based on our third quarter performance. We expect revenue to be in the range of $4.3 billion to $4.325 billion, and earnings per diluted share to be in the range of $2.50 to $2.54. The guidance assumes the current U.S. economic environment continues and does not worsen going forward. It also assumes no impact for additional share repurchases. Now I would like to turn the call over to Mike Hansen for more details of the third quarter.

J. Michael Hansen

Good evening. As Bill mentioned, total revenue increased 6.3% from the third quarter of last year with total company organic growth being 6.9%. Total company gross margin for the third quarter was 41.1%, which is down from last year's third quarter gross margin of 42.1%, but slightly better than this year's second quarter gross margin of 40.7%. I will discuss these items in more detail by segment. Before doing so, let me remind you that there were 64 workdays in our third quarter, which is 1 less than last year. Our fourth quarter will have 66 workdays, which is the same as last year's fourth quarter. As a planning note for fiscal '14, we will have 65 workdays in each quarter for a total of 260 workdays. This creates year-over-year workday differences in each quarter except the second, and results in 1 less workday for the entire fiscal year. We have 4 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. The rental uniforms and ancillary products operating segment consists of the rental and servicing of uniforms, mats, towels and other related items. This segment also includes restroom supplies and other facility products and services. Rental uniforms and ancillary products revenue accounted for 70% of company revenue in the third quarter and totaled $748.9 million, which is up 3.9% compared to last year's third quarter. Organic growth was 5.5%, which is a nice uptick from the 4.5% organic growth rate in the second quarter. Sales rep productivity continued to be strong and we did see a slight pickup near the end of the quarter in our net adds stops metric. Our rentals segment gross margin was 41.9% for the third quarter, a 120 basis point decrease from last year's third quarter gross margin of 43.1%. Energy-related costs were down 10 basis points from last year's third quarter. Bill touched on the primary reasons for the decreased gross margin: the impact of 1 less workday, the higher material cost and service costs associated with added route capacity. The third quarter gross margin of 41.9% was the same as the second quarter. The negative impact of 1 less workday in the third quarter was offset by the impact of the processing system write-off in the second quarter. Our uniform direct sales operating segment includes the direct sale of uniforms, branded promotional products and other related products to national and regional customers. Uniforms and other related products are also sold to local customers, including products sold to rental customers through our direct sale catalog. Uniform direct sales revenue accounted for 12% of company revenue in the third quarter and totaled $126.1 million, which represented sales growth of 15.6% compared to last year's third quarter. As Bill mentioned, we had several rollouts in the third quarter in our Fortune 1000 business, including the largest single customer rollout in Cintas' history. Uniform direct sales gross margin was 29.2% for the third quarter, down from last year's third quarter gross margin of 30.5%. This segment's gross margin can move from quarter-to-quarter due to changes in mix of product and timing of program rollouts. And this year's third quarter revenue included a much higher mix of Fortune 1000 national account sales, which tend to have slightly lower gross margins than our hospitality and gaming business. Our first aid, safety and fire protection services operating segment includes revenue from the sale and servicing of first aid products, safety products and training and fire protection products. First aid, safety and fire protection revenue accounted for 10% of company revenue in the third quarter. Revenue was $112.9 million, which is up 11.3% over last year's third quarter revenue. Organic growth was 6.9%, which is a nice improvement over the 4.8% organic growth rate in the second quarter. This segment's gross margin was 44% in the third quarter, which is up 80 basis points from the 43.2% in last year's second quarter, and the 42.4% in this year's second quarter. Our first aid and safety gross margins were very strong due to continued efficiencies gained by the good performance in this business. Our document management services operating segment includes document destruction, storage and imaging services and that accounted for 8% of third quarter total company revenue. Document management revenue totaled $87.8 million, which is 8.9% higher than last year's third quarter. Revenue increased organically by 5.8% compared to last year. We have lapped last year's steep drop in recycled paper prices and now have better year-over-year comps. This year's third quarter average recycled paper price remain relatively low at $140 per ton, but this is slightly higher than last year's third quarter average of $135 per ton. This $140 average price also remained lower than our expected third quarter paper price of $160 per ton. Our updated guidance for the fourth quarter assumes that recycled paper prices will stay roughly at the $140 level. The third quarter gross margin of 47.1% is comparable to last year's third quarter of 47%. Switching to selling and administrative expenses, SG&A was 28.7% as a percentage of revenue in the third quarter, which is up slightly from the 28.5% in last year's third quarter. As Bill mentioned, medical and auto and other liability claims were up a combined 110 basis points. Offsetting these increases were better leveraging of our G&A functions and constant challenging of our cost structure. Our effective tax rate was 36.1% for the quarter compared to 37% last year. The effective tax rate can fluctuate from quarter-to-quarter based on tax reserve builds and releases relating to specific discrete items. For the full fiscal 2013 year, we expect our effective tax rate to be approximately 37%, which is slightly higher than last year's 36.8%. Last year's rate was impacted favorably by the resolution of federal audits.

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