Earnings Call Transcript
CINTAS CORP (CTAS)
Earnings Call Transcript - CTAS Q2 2021
Operator, 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. Paul Adler, Vice President, Treasurer and Investor Relations. Please go ahead, sir.
Paul Adler, Vice President, Treasurer and Investor Relations
Thank you, and thank you everyone for joining us. With me today is Scott Farmer, Cintas Chairman of the Board and Chief Executive Officer; Todd Schneider, Executive Vice President and Chief Operating Officer; and Mike Hansen, Executive Vice President and Chief Financial Officer. We will discuss our second quarter results for fiscal 2021. After our commentary, 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. I'll now turn the call over to Scott Farmer.
Scott Farmer, CEO
Thank you, Paul and good morning, everyone. The COVID-19 coronavirus pandemic remains a significant disruption to the economy. In the final month of our fiscal second quarter, November, the COVID-19 virus counts surged from about 100,000 per day at the beginning of the month to about 250,000 per day now. Not surprisingly economic indicators such as jobs growth, unemployment, and retail spending reflect an economic recovery that slowed considerably as the fall months progressed and the virus counts increased. Despite the macroeconomic headwinds, I’m pleased with our second quarter financial performance, which exceeded expectations. Our employees, whom we call partners have not wavered in their passion for getting businesses ready for the workday. They're providing essential products and services to help keep our customers and their places of business clean and safe. These include hand sanitizer services, professionally laundered healthcare scrubs and isolation gowns, first aid products, sanitizing wipes, face masks, gloves, and fire protection services as well as many others. The conversion of no programmers, the do-it-yourselfers, if you will, remains robust. Our supply chain and service network enable us to increase service to existing customers and add new customers by procuring and providing items in short supply. And our Net Promoter Score, which we use to measure customer satisfaction has risen dramatically to an all-time high. We find ourselves today, however, at a time of increasing uncertainty. A number of states and municipalities have reinstituted temporary economic restrictions in response to rising COVID-19 cases. Others are considering them. On the other hand, vaccines are being distributed and the U.S. government continues to discuss additional economic stimulus. The uncertainty of the resolutions of these impactful events makes providing near-term guidance very difficult. Therefore, we're not providing financial guidance at this time. However, if we're able to gain clarity before the end of the quarter, we'll provide an update in advance of our third quarter earnings release. That said, there is much that does remain certain. Our employee partners reflect the steadfast Cintas culture. They're always striving to exceed the expectations of our customers to maximize the long-term value of Cintas for its shareholders, employee partners, and other stakeholders. The result is consistently strong financial performance with Cintas growing revenue and EPS in 49 of the past 51 years. I remain certain of our value proposition of getting businesses ready for the workday by providing essential, unparalleled image, safety, cleanliness, and compliance. It has never resonated more than it does today. I remain certain of our addressable market, namely the millions upon millions of businesses that are not currently Cintas customers, many of whom are not in a program with recurring service but could benefit from at least one Cintas product or service, and I'm certain that Cintas is well positioned for years to come. Now I'll turn it over to Mike for commentary on the financial results of the quarter. Mike?
Mike Hansen, CFO
Thank you, Scott, and good morning. Our fiscal 2021 second quarter revenue was $1.76 billion compared to $1.84 billion in last year’s second quarter. Earnings per diluted share from continuing operations or EPS were $2.62, an increase of 15.4% from last year’s second quarter. Organic revenue adjusted for acquisitions, divestitures, and foreign currency exchange rate fluctuations declined 4.4% for the second quarter of fiscal '21. Organic revenue for the Uniform Rental and Facility Services operating segment declined 3.6%. Organic revenue for the First Aid and Safety Services operating segment increased 14.5%. Gross margin for the second quarter of fiscal '21 was $819.9 million compared to $852.4 million in last year’s second quarter. Gross margin as a percentage of revenue increased 50 basis points to 46.7% for the second quarter of fiscal '21 compared to 46.2% in the second quarter of fiscal '20. Selling and administrative expenses as a percentage of revenue were 26.6% in the second quarter of fiscal '21 and 28.1% last year. Fiscal '21 second quarter results benefited from lower discretionary spending and increased sales rep productivity. Operating income for the second quarter of fiscal '21 of $352.9 million increased 5.5%. Operating margin was 20.1% in the second quarter of fiscal '21 compared to 18.1% in the second quarter of fiscal '20. Our effective tax rate on continuing operations for the second quarter of fiscal '21 was 13.3% compared to 20.1% last year. The tax rate can move from period to period based on discrete events, including the amount of stock compensation expense. Net income from continuing operations for the second quarter of fiscal '21 was $284.9 million, an increase of 15.7%. EPS was $2.62, an increase of 15.4% from last year’s second quarter. In the second quarter of fiscal '21, certain Uniform Rental and Facility Services operating assets were sold. The pre-tax gain on sale of $18 million was recorded in the selling and administrative expenses and impacted operating margin by 100 basis points. The pre-tax gain and related tax benefit impacted EPS by $0.25. Our balance sheet and cash flow remained strong. Our leverage calculation for our credit facility definition was 1.6x debt to EBITDA. We have an untapped credit facility of $1 billion. For financial modeling purposes, please note that there is one more workday in our fiscal '21 than in our fiscal '20. One more day will benefit fiscal '21 total revenue growth by 40 basis points. One more workday also benefits operating margin and EPS. Fiscal '21 operating margin will be about 12.5 basis points better in comparison to fiscal '20 due to one more day of revenue. In fiscal '20, each quarter contained 65 workdays. In fiscal '21, workdays by quarter are 66 in Q1, 65 in Q2, 64 in Q3, and 66 in Q4. Please keep these differences in mind when modeling on a year-over-year and sequential basis. I'll now turn the call over to Todd Schneider to discuss the performance of each of our businesses.
Todd Schneider, COO
Thank you, Mike. As Scott stated, COVID-19 remains a significant disruption to the economy. Every business in the U.S and Canada has been impacted. Many of our customers that have remained open are not yet operating at the same level of business as before the pandemic started because the virus has a negative impact on health and the economy. Our employee partners continue to work with urgency to offset these headwinds. Over the past couple of quarters, we've provided some examples of their interactions with both new and existing customers to give a better understanding. Many of those examples highlighted customers in the industries of healthcare, education, and state and local government and products and services including scrubs, hand sanitizer service and masks. For the second quarter of the fiscal year, the amount of Uniform Rental and Facility Services new business sold to healthcare, education, and government customers is double the amount in the prior-year period. And the amount of First Aid, Fire, and Other new business sold to customers in healthcare, education, and government is 6x the amount sold in the same period last year. Some of this new business is recurring and some may not repeat. Nevertheless, the results are really impressive. Also, the number of scrub dispensing machines installed in our first two quarters doubled last year's number, and since the virus appeared, our employee partners that provided businesses with over 350,000 hand sanitizer dispensers and over 125 million masks. I’m truly in awe of the accomplishments of our team in this challenging time. And I'm excited about the opportunities for Cintas post-pandemic which seems to be finally appearing on the horizon. With that, I'll turn now to the second quarter financial performance of our businesses. Uniform Rental and Facility Services operating segment includes the rental and servicing of uniforms, health care spreads, mats, and towels in the provision of restroom supplies and other facility products and services. The segment also includes the sale of items from our catalogs to our customers on route. Uniform Rental and Facility Services revenue was $1.41 billion compared to $1.47 billion last year. Our Uniform Rental and Facility Services segment gross margin was 47.5% for the second quarter, compared to 46.6% in last year's second quarter. Higher inventory amortization expense of 80 basis points was more than offset by the benefits of lower production and service expense as a percent of revenue. Our First Aid and Safety Services operating segment includes revenue from the sale and servicing of first aid products, safety products, personal protective equipment and training. This segment's revenue for the second quarter was $194.4 million compared to $169.7 million last year. The First Aid segment gross margin was 43.0% in the second quarter, compared to 48.4% in last year's second quarter. Lower production and service expenses as a percent of revenue compared to last year's second quarter were more than offset by higher cost of goods sold from the increased proportion of revenue from personal protective equipment, such as masks, and gloves. Our Fire Protection Services and Uniform Direct Sales businesses are reported in the all other category. Our Fire business historically grows each year at a strong pace. The Uniform Direct Sale business growth rates are generally low single digits and are subject to volatility such as when we install a multimillion dollar account. Uniform Direct sale, however, is a key business for us and its customers are often significant opportunities to cross sell and provide products and services from our other business units. All other revenue was $152.1 million compared to $204.1 million last year. The Fire business organic revenue declined 3.3% due to the inability to access some businesses because of closures. The Uniform Direct Sale business organic revenue declined 51.2%. Revenue from our airline, cruise line, hospitality and gaming customers largely falls within this segment. These industries continue to be among the hardest hit by the pandemic. That concludes our prepared remarks. We're happy to answer your questions.
Operator, Operator
We'll take our first question from Andrew Steinerman with J.P. Morgan.
Andrew Steinerman, Analyst
Good morning, everyone. Could you give us a sense about the month of November in terms of organic revenue trends for rental, and if you can make a comment into the month of December that would be great.
Scott Farmer, CEO
Hi, Andrew, this is Scott. Yes, I can provide more detail on that. Throughout the quarter, we saw an improvement in revenue trends for November. In the Uniform Rental and Facility Services segment, the rental organic growth was minus 1%. For First Aid and Safety in November, the organic growth was 14%. Fire also showed improvement throughout the quarter, ending November down 1%. It's worth noting that around mid-November, we experienced some impact from state restrictions on businesses. This affected the trends, but it did not worsen them beyond that point. So, it's a bit unpredictable moving forward. However, as you can see from November, we maintained a positive trend. I believe second quarter revenue grew about 2.7% sequentially compared to the first quarter.
Andrew Steinerman, Analyst
Could you make a comment about December?
Scott Farmer, CEO
I would say through the first couple of weeks, we were running around where we were in November.
Andrew Steinerman, Analyst
Great. Okay. Thanks, Scott.
Scott Farmer, CEO
Yes.
Operator, Operator
We'll take our next question from Seth Weber with RBC Capital Markets.
Seth Weber, Analyst
Good morning, everyone. I have a couple of questions regarding the margins. I'm trying to assess our current situation with expenses coming back. Mike, last quarter you mentioned that there was about 100 basis points of lower discretionary spending. Have any of those costs started to return in the second quarter, and how should we consider that for the rest of the year? Thanks.
Mike Hansen, CFO
Yes, we are continuing to manage our costs closely due to the current environment. The difference in travel and meetings expenses from last year was around 100 basis points in the first quarter and about 40 basis points in the second quarter. Typically, we travel more at the beginning of our fiscal year, but we still saw a 40-basis-point benefit. We will keep monitoring the situation. I understand that our operational teams are eager to visit our locations and customers, but due to the current COVID case levels and the overall environment, we will maintain a cautious approach.
Seth Weber, Analyst
Okay. Can you talk about whether you have seen any relief on the cost side in the First Aid and Safety category? I know there have been some cost pressures there. Has that eased up a bit as supply availability has improved? Any comments on the First Aid and Safety expense cost side?
Todd Schneider, COO
Seth, this is Todd. Regarding the First Aid business, there are still some PPE items that are quite difficult to obtain. We have been fortunate to maintain a good inventory position to support our customers with these items, although PPE remains in limited supply. This has affected our costs in some situations. However, we have approached this with a long-term perspective, invested wisely, and our customers truly appreciate our ability to provide products and services, including PPE and other items, to help them navigate these challenging times.
Mike Hansen, CFO
We appreciate the sequential improvement in gross margin from approximately 40% in Q1 to 43% in Q2, and we saw strong performance in our First Aid cabinets during the quarter. As mentioned in September, the mix of PPE has decreased slightly, with growth in that segment dropping from over 20% in Q4 to 17% and then to 14.5% in Q2. We are beginning to observe that some of the PPE items are shifting into maintenance mode, as we discussed in previous quarters, and this mix change, along with the enhanced performance of the First Aid cabinets, has supported the gross margin. Once we reach a more normalized environment, we certainly believe that the gross margins for First Aid will trend back to pre-COVID levels. There are no structural changes in the business that would suggest otherwise.
Operator, Operator
We will take our next question from George Tong with Goldman Sachs.
George Tong, Analyst
Hi, thanks. Good morning. You mentioned that in the first several weeks of December, Uniform Rental trends are running around where you were back in November. Can you discuss changes you've seen, if any, around new business and retention trends over the past several weeks?
Scott Farmer, CEO
Our new business numbers continue to perform very well. We still believe that our value proposition is significant in the current environment, which allows us to attract new customers. So far, we haven't noticed a change in our lost business rates. However, due to government restrictions, some customers have temporarily closed their businesses until the restrictions are lifted. This shift has been observed since about mid-November in the economy, particularly in states and cities such as California, Illinois, New York, Washington, Oregon, and even Toronto. While these restrictions are affecting our customers, we have not seen a notable change in lost business rates.
George Tong, Analyst
Got it. That’s helpful. And then, can you talk a little bit about how much growth you're seeing from the non-programmer market versus your existing customers, and how much health care as a vertical is contributing to growth directly?
Scott Farmer, CEO
Sure. The non-programmer market has been consistently tracked for many years, and it accounts for between 60% and 65% of our new business customers, a range that remains stable today. As I mentioned earlier, there are millions of businesses without a program that we can provide, and we are confident in our ability to convert them. In the health care sector, if we categorize a non-programmer as one without a rental program, most scrubs found in hospitals are typically sold directly—some are purchased by individual health care workers, while others are bought by hospitals for their departments. Converting these to a rental program constitutes a conversion of a non-programmer. Additionally, we are seeing significant success with isolation gowns, which are usually sold as disposable items. We offer a rentable option that can save hospitals and health care providers money when switching from a direct sale program to a rental program. We consider this successful transition as a non-programmer conversion within the health care space.
Todd Schneider, COO
George, it's Todd. I want to expand on a few things Scott mentioned. Our no programmer business as a percentage of our total remains quite steady. What is changing is that it allows us to reach audiences and customers we haven't been able to engage in the past, largely due to our access to essential products and services they need for their businesses and to support their customers and employees, ensuring confidence for everyone in the workplace. Scott talked about the success we've had in the medical field with products like isolation gowns, hand sanitizer, and scrubs, which are in high demand. He noted that the isolation gown market has largely been driven by direct purchases, and what we're offering has appealed strongly to our prospects and customers. Our service is environmentally friendly; we’re reusing garments instead of discarding them, which saves them considerable money. Moreover, instead of hospitals struggling to source isolation gowns amidst the demand, our offerings are more comfortable than what they previously used. We've also introduced technology that tracks how many times the garments have been processed, ensuring they meet the required specifications. This has resonated well with health care customers. As we noted in our last earnings release, demand for scrubs has also increased significantly. Many individuals are uncomfortable washing their scrubs at home due to concerns about contamination on the way back. Overall, this has led to very good demand. In these cases, we consider these as no programmers, where we might be conducting some business with health care organizations, but we're significantly expanding those relationships.
Operator, Operator
We'll take our next question from Hamzah Mazari with Jefferies.
Mario Cortellacci, Analyst
Hi, this is Mario Cortellacci filling in for Hamzah. I appreciate the time. Regarding the trends in November and the continuation into December, could you provide more insights into what you're observing in your end market? I assume it's likely similar to what we experienced earlier in the year, with high-risk industries being affected more significantly. Is that accurate, or could you share some details about the factors impacting your end market exposure?
Scott Farmer, CEO
Yes, certainly. It comes down to specific industry segments and geographic areas. The sectors most affected include travel, hotels, cruise lines, and in some cases, restaurants and movie theaters, primarily due to restrictions and the general reluctance of people to gather in places like theaters. The situation varies depending on the restrictions in different locations. Recently, we've noticed an increase in the number of states and municipalities implementing restrictions as we approached the end of November. It's uncertain if this trend will persist through the holiday season. For instance, Governor Newsom in California has enforced strict restrictions that are set to last until January 4th, but it's unclear whether they will be extended, as has happened previously, or if he will ease them as planned. The changes we've witnessed since mid-November are primarily in those affected states and municipalities. I believe we are currently experiencing a temporary low, which won't approach the levels of our fourth quarter last year. At that time, nobody—including governors and business leaders—foresaw the severity or length of the situation. However, after 8 or 9 months of experience and with vaccines starting to be distributed, there is hope on the horizon, and this period will eventually pass. I hope this gives you some insight, and I'm here to provide more specific information if you have any questions.
Mario Cortellacci, Analyst
No, that was helpful. And then going back to health care for a second, just I guess, could you give us a sense of what the competitive landscape looked like there? So I think reasonably one of your competitors came out with a new scrub line. You had mentioned the isolation gowns as being one of your differentiated products, which is, I’m assuming, helping you win business. Just wondering how those conversations are going with customers regarding competition? And then also could you touch on how you're positioning your scrub dispensing system to your advantage?
Scott Farmer, CEO
Yes. Todd, you want to take this one, and I'll chime in.
Todd Schneider, COO
In the health care market, the situation varies depending on the specific area, whether it's acute or non-acute care, or which department you're discussing. Generally, ISO gowns and scrubs are typically acquired through direct purchases; ISO gowns, especially disposable ones, are commonly procured this way. There are lending companies that serve these customers. To summarize, it generally falls into a direct purchase or disposable market, with any reusables generally provided by linen companies. Regarding our scrub dispensing system, it has been performing exceptionally well for our business and our clients. The demand is evident, as seen when you go into a grocery store and observe people in scrubs, which typically belong to hospitals. In recent times, due to challenges in accessing scrubs, individuals tend to hoard them, leading to increased purchasing of the least expensive options available. We've altered this dynamic by offering scrubs that people prefer to wear because they are comfortable and stylish, and we are continuously investing in improved fabric technologies. This approach ensures accessibility and accountability; when someone needs a scrub, they can easily get one without the hassle of taking it home for laundering. This has proven to be very appealing to our healthcare clients. As I mentioned earlier, we've doubled the number of scrub installations compared to last year at this time, showing strong momentum that we're excited about.
Scott Farmer, CEO
Let me add one thing regarding the competition. Todd mentioned that scrubs and isolation gowns are typically direct sale items. It's important to understand that developing a laundry service for these items is quite challenging, and traditional direct sale competitors may not even consider it. We offer a unique opportunity for customers to transition to a rental program, which traditional competitors cannot provide due to their limitations. This gives us a significant competitive edge over them. Our technology, including scrub machines and inventory tracking dispensing units, allows us to effectively manage how often an isolation gown is processed before it's taken out of service. Traditional competitors lack these capabilities. When it comes to rental companies like linen and uniform rental providers, we've been in this business for a long time. Our trained salespeople and service providers specialize in the healthcare market, giving us a multiyear lead over what you might view as our traditional rental competitors. We are confident in this position, which is reflected in our success throughout this process and during the pandemic. I wanted to provide that context as it relates to healthcare.
Operator, Operator
We'll take our next question from Manav Patnaik with Barclays.
Manav Patnaik, Analyst
Thank you. Good morning. Scott, if I could just ask you just again from a competitive standpoint, just some broader commentary, I guess outside of health care, like have you seen any changing dynamics that people are getting tight, aggressive, or is it some more consolidation going on? Just curious, any color there?
Scott Farmer, CEO
Yes. We have observed some aggressive pricing in the marketplace. Typically, when competitors face issues with their existing customer base and see a decline in revenue, they respond by lowering prices. This trend is not new; we've encountered similar low pricing efforts in the past as competitors try to capture our business. This behavior can vary from market to market, involving either smaller players or larger national companies that feel the need to take action to secure accounts. Regarding overall pricing, we've had to raise prices on fluctuating items like gloves, face masks, hand sanitizer, and other PPE due to increased costs. However, for our recurring revenue across all our businesses, we have not increased prices during the pandemic. In fact, particularly in our rental division, we haven't raised prices for our customers in about a year and a half. This decision is strategic as we believe it is not the right time to increase prices during a global pandemic. This approach may have positively influenced our Net Promoter Scores, which we use to gauge customer satisfaction. That summarizes our current stance on pricing.
Todd Schneider, COO
Manav, I want to touch on a couple of items related to our approach with customers. As Scott mentioned, we haven’t raised recurring revenue pricing in over 18 months. Our strategy is centered around being caring, consistent, and flexible. We recognize that this is a challenging time for both our customers and prospects, so we aim to respond appropriately. Scott highlighted that this approach is reflected in our customer satisfaction scores, tracked through Net Promoter Scores. We focus on the lifetime value of our customers, aiming to build lasting relationships rather than seeking short-term gains. I believe this is evident in our Net Promoter Scores and will continue to influence how customers perceive us in the long run.
Manav Patnaik, Analyst
Got it. That's helpful. And also I think you've given examples on how basically your scale plays totally to your advantage in these time shares those kind of heightened demand. Have you seen, maybe some of your smaller competitors just going to be financially constrained? And is that present even more opportunities now?
Scott Farmer, CEO
We consider ourselves an equal opportunity competitor. If any of our competitors in a specific market face challenges such as securing supplies or serving their customers, we are ready to step in and offer those products and services. Occasionally, we observe issues with a competitor, and we respond on a case-by-case basis. There is still some uncertainty about how the situation will evolve and how long it will last, with differing opinions on the matter. However, I believe this could create future opportunities for acquisition, as potential sellers might want to restore their revenue to pre-COVID levels to have a more substantial business to sell. We will handle these situations as they arise, and they certainly represent opportunities for us as well.
Operator, Operator
We'll take our next question from Andrew Wittmann with Baird.
Andrew Wittmann, Analyst
Thank you for answering my questions. This one is directed at Mike. Looking back at 2020, it has been a remarkable yet challenging year for many. Investors will likely reflect on how Cintas managed through these times, especially with your margin percentage increasing despite a decline in revenue. Mike, as we look ahead and begin to analyze the impact of COVID, how should we think about the margins? You've mentioned the travel-related discretionary benefits of 100 basis points last quarter and 40 this quarter. Are there other factors that could pose margin challenges throughout the year as we assess the ongoing effects of COVID? I'm curious about elements like incentive compensation and fuel prices, along with any concerns on the production side. What other high-level considerations should investors keep in mind as we approach the one-year mark since COVID began?
Mike Hansen, CFO
Yes, it's been a challenging year, requiring a lot of management of different costs and structures. It has certainly been a challenge. However, as we move forward, we have learned about areas such as travel and how we can operate more efficiently. I believe we will achieve permanent savings in some areas. While some costs will return, I don't expect to see a significant movement in those metrics. Looking ahead, we want to focus on long-term growth. We continue to staff positions that generate revenue to position ourselves for growth, which may result in some additional spending in service and sales departments. Scott has managed the business very effectively during this time, and I expect that to continue. We will remain very aware of our margins and costs, aiming for healthy incremental margins. Therefore, the only changes I foresee are minor increases in travel expenses and additional staffing for revenue-generating positions necessary for growth.
Andrew Wittmann, Analyst
Okay, great. That's my only question for today. Have a good holiday season, guys.
Scott Farmer, CEO
Thank you.
Mike Hansen, CFO
Thank you.
Scott Farmer, CEO
You too.
Operator, Operator
We'll take our next question from Tim Mulrooney with William Blair.
Tim Mulrooney, Analyst
Yes, good morning. Just one for me as well on employee retention, which I know is a key initiative for the firm and something y'all track pretty closely. I'm curious how that's trended through the pandemic. You get with furloughs and disruptions to your routes, from temporary shutdowns. If employee turnover has been something that's been harder to manage over the last several quarters, or it's actually been easier because the labor market isn't as tight as it's been relative to the last several years. Thank you.
Todd Schneider, COO
Tim, this is Todd. Thanks for the question. Partner retention is always challenging. However, I must say that our performance since the beginning of the pandemic has been impressive, and results continue to improve. Our partner base consists of an outstanding group of individuals who are relentless, creative, and take great pride in their work to help businesses operate successfully in this environment. There is a strong sense of energy within the organization, and everyone is proud of what they do. We have a fantastic team of leaders and frontline partners throughout the organization, and we are very pleased with that. So yes, things are going quite well, and we are optimistic as we move forward. Facing tough situations, like the pandemic, has been extremely challenging not only for us but for the entire world. However, such challenges make you better and stronger. We have learned a lot about our partners and their resilience, and it has been a true pleasure.
Scott Farmer, CEO
Thank you, Tim.
Operator, Operator
We'll take our next question from Gary Bisbee with BFA Securities.
Gary Bisbee, Analyst
Good morning. I wanted to clarify something. Todd mentioned that new businesses in the health care, education, and government sectors doubled year-over-year, but then he referenced something else that was not clear. What were those numbers? Yes, that’s correct. We’re pleased to elaborate. I was referring to two different sectors. In our rental and facility services business, the new businesses in health care, education, and government have indeed doubled. Additionally, for our First Aid and Fire services, new business in those same sectors is up significantly. As I noted earlier, not all of that growth will be sustainable, but we are very encouraged by our performance in these areas.
Mike Hansen, CFO
Yes. So in total, our new business is very good. We're very encouraged by that. The trend lines are great. The productivity is at an all-time high. It's replacing a lot of revenue of customers that are closed. And for those, it's also replacing a lot of revenue for customers who are maybe open, but certainly not at the same levels as what we'd expected in a new more normalized type economy.
Operator, Operator
Okay. And then just if I could one financial question on cash flow, it's obviously been quite strong. How do you think about two factors. One, CapEx coming back to more normal levels? Is that just a matter of revenue getting back and you’re bringing the spend back or anything else we should think timing? And then the other one on inventory, inventory days is up a lot, I guess, in part sales down, but also building inventory for all these newer items, PP&E and whatnot, how do you think about inventory levels in a more normalized revenue environment at some point in the future? Are they likely to be higher than they've been? And is that something that will continue to build and have an impact on capital. Thank you.
Todd Schneider, COO
Let's begin with capital expenditures. We are likely to see capital expenditures stay below historical levels until we navigate through the COVID crisis and the economy rebounds. Even now, our spending is about 60% for growth and 40% for maintenance. However, I expect it to remain lower for now as everyone is a bit more cautious. Regarding inventory, it's crucial to note that we are working diligently to manage the supply chain and meet demand for these hard-to-obtain items. This is the main reason for the increase in our inventory; I don't anticipate a sudden decrease in the need for these products. Instead, any decline will be gradual, and we will gain insight into this as the economy improves and COVID vaccines are distributed. Many of these products will likely be in demand at levels higher than pre-COVID for an extended period. Currently, we are not facing issues with slow-moving inventory. I can say that our ability to stock these products has given us a significant competitive edge in the market. Because we have items like masks, gloves, and hand sanitizer, potential customers who typically do not engage with us are now paying attention to our capability to supply these COVID-related goods, which opens doors for us to offer additional services. For instance, a company interested in hand sanitizer may end up purchasing uniforms, restroom supplies, entrance mats, mops, and cleaning chemicals, alongside the sanitizer. This situation has been a considerable competitive advantage for us. I believe it contributes to our improved Net Promoter Score for customer satisfaction and strong new business results. Our solid balance sheet has empowered us to make these investments, and our supply chain has excelled in procuring these products, allowing us to attract new accounts and meet our customers' needs effectively.
Operator, Operator
Let's take our next question from Kevin McVeigh with Credit Suisse.
Kevin McVeigh, Analyst
Great, thanks so much. Hey, I wonder if you could give us a sense of across the client base, how many are in percentage numbers? Maybe how many are inactive today? And is there a way to think about where the average customer is in terms of percentage of prior peak, just to get a sense of just the potential to scale as things start to reaccelerate from a COVID perspective, we are covering that.
Scott Farmer, CEO
That's difficult for us to say, because in many ways, it's a moving target. We have had customers that were open, but due to regulations or restrictions, they had to shut down temporarily or reopen only at 50% capacity or at a lower level than before. However, we haven't provided specific figures because they fluctuate so much that what I tell you today could be different next week. It really depends on who might impose new restrictions. Therefore, we haven't gone into that level of detail, as I hesitate to do so because it could be misleading given how much it changes.
Kevin McVeigh, Analyst
Okay. Thank you. And then just in the kind of post-COVID world, you think about how much of the demand is structural. Is there a way to think about that, again, to the core business, and to me, it seems like, obviously, health care is going to be a more significant contributor to the business, but just any incremental step up and how much of that is kind of structural versus maybe starts to kind of normalize.
Scott Farmer, CEO
We have gained a lot of insight through this process. One of the very encouraging aspects is that we've improved our communication with both existing customers and potential clients regarding all the services we can provide. As a result, we are increasing sales to existing clients and new prospects. They might initially engage us for a specific service, but because they know about our other offerings, they can reach out when those needs arise. This shift has been significant for us. I believe the solutions we offer will be essential for these customers in the long run, helping to ensure safety for their businesses, employees, and clients. It allows for a clean work environment and compliance with regulations, including those from the insurance industry and fire safety requirements. We are enthusiastic about our current position and the future possibilities ahead.
Todd Schneider, COO
Kevin, it's Todd. As an example …
Kevin McVeigh, Analyst
Hey, Todd.
Todd Schneider, COO
We previously mentioned in an earlier call that we started working with a major national bank chain with whom we had no prior business, and we are now supplying hand sanitizer to every one of their branches. Additionally, we are discussing other product needs they have for their facilities. We are also in conversation regarding our Fire service, which they require. The focus is on where they source these products and centralizing their expenditures, often leading to cost savings. This is just one example of the many similar opportunities happening every day with our sales and service organization. As Scott noted, this enhances our position because there were previously individuals who wouldn't engage with us, but now they are willing to connect due to our inventory and infrastructure, which strengthens our long-term prospects significantly.
Operator, Operator
We'll take our next question from Scott Schneeberger with Oppenheimer.
Scott Schneeberger, Analyst
Thank you very much. Good morning. In the Other segment, I'm curious about your visibility there. You're experiencing some new wins but also facing some challenges. Could you provide a breakdown between Fire and Direct Sales regarding your visibility? The essence of my question is about how your visibility relates to your ability to manage your operating expenses. Thank you.
Scott Farmer, CEO
The Fire service business is recovering similarly to the Rental and Facility services segment. Earlier, I mentioned that their November organic growth rate was down 1% from pre-COVID levels. We have a clear view of what's happening in that business and I believe that, much like the rest of the economy and the rental division, we will see a similar recovery. Regarding the Direct Sale business, a significant portion of that operates in hospitality and travel, which is more uncertain. This includes hotels, airlines, cruise ships, casinos, and food service. I expect these areas will take longer to recover, but I anticipate a substantial rebound eventually. There is a considerable pent-up demand for vacations, hotel stays, and a safe flying experience. Once vaccines are widely distributed and herd immunity is reached, we might see airlines offering special rates to entice travelers, and hotels and resorts will likely do the same. Las Vegas will also make efforts to bring customers back, potentially as early as next summer, depending on vaccination rates. If these changes succeed in those sectors, they will likely benefit other businesses as well. People will want to return to restaurants, movie theaters, concerts, and bars, and I believe that time will come. We still need time to gauge the vaccine rollout, which is why I maintain that we are currently in a temporary phase. As we move forward and gain more clarity, I think we will see an uptick in economic activity, perhaps becoming more pronounced quarter by quarter as vaccinations progress.
Scott Schneeberger, Analyst
Thanks, Scott. I appreciate that insight. As a follow-up, I'm interested in your interest in mergers and acquisitions and your observations in that space, especially given your strong position as mentioned during the call. Additionally, could you share some thoughts on transitioning to a quarterly dividend and the overall return of capital strategy? Thank you.
Scott Farmer, CEO
Yes. We were among the last to offer annual dividends. After much discussion at the Board level, we decided to make a change. We've listened to our shareholders who have expressed concerns about cash flow, and we've responded accordingly. We believe this change is beneficial for us and our shareholders. Can you remind me of the first part of your question?
Mike Hansen, CFO
M&A, Scott.
Scott Farmer, CEO
Thank you, Mike. I apologize if you missed this, but regarding M&A, we are currently exercising caution due to the stage of the recovery. However, we are capable of pursuing acquisitions across our businesses. We will conduct thorough evaluations at this time to ensure we fully understand the performance of any targeted business. If we identify the right deal, the right business, and the right price, we are open to making acquisitions. There seems to be some hesitance from sellers if their revenue has not returned to pre-COVID levels, which may lead them to hesitate in selling. This could result in a temporary slowdown in M&A activity, but as the economy improves, we anticipate an increase in such activities, and we would like to actively participate.
Operator, Operator
We'll take our next question from Toni Kaplan with Morgan Stanley.
Toni Kaplan, Analyst
Thank you. I was hoping you could provide some clarification on the operating assets that were sold during the quarter. Trying to understand what those were and was that a cost-saving measure, given the uncertainty? And does this reduce future capacity at all? And just how does it impact the run rate margin structure, if at all? Thanks.
Scott Farmer, CEO
Yes, it was mainly a couple of key focuses. We had operations in some remote areas that didn’t provide significant growth opportunities, so a lot of resources were dedicated to those operations, which weren't vital to us. We also experimented with some services but decided we had better growth opportunities in other segments of the business. Those are the areas we sold, and it wasn't material, with a total revenue run rate of about $50 million annually. Therefore, I don’t anticipate any short-term, mid-term, or long-term impact on our run rate.
Toni Kaplan, Analyst
That's helpful. And this was asked in a different way already, but just want to make sure I understand the comments that you've made today sound like things are doing fine, improving in many cases, but there have been some new lockdowns and potential for more. So that's your reservation for not providing the 3Q guidance. Just Is that fair and what do you see directionally, I guess, as the range of revenue growth scenarios, is it better than 4Q on the downside, but better than this quarter on the upside, like just trying to understand how you're viewing the range. And obviously, there's a lot of uncertainty. So not trying to nail you down on it, just what's the upside and downside? Thanks.
Scott Farmer, CEO
Let me clarify this situation. The timing of our quarter and this call is influencing some issues we're facing. There is considerable uncertainty as we look ahead over the coming weeks and months. This includes the increasing number of virus cases and government restrictions being implemented. Currently, it’s unclear if more governors and mayors will impose additional restrictions or how long the existing ones will last. Typically, during the period between Christmas and New Year’s, many of our customers close their facilities for the holidays, but this year it's uncertain whether that will be extended. We also have an important Senate election in Georgia coming up, which adds to the unpredictability. When we discussed our projections, we considered various scenarios. For instance, what if a group of governors decided to maintain restrictions for three more months, given that the vaccine is on the horizon? This uncertainty complicates our ability to estimate the lower end of our range. Conversely, what if Governor Newsom reopens California on January 4? This has led us to a broad range of possibilities that we felt wouldn’t be helpful for you. We know that one of the aspects you appreciate about our company is our predictability when providing guidance. However, in this instance, we believe that any guidance we provide could lead to significant variability based on your outlook for the economy. Therefore, we've concluded that it wouldn't be sensible to provide guidance during this time. I personally don’t expect the situation to mimic what occurred in the fourth quarter, which was unprecedented with shelter-in-place orders enacted rapidly across many states. Looking ahead, I don't expect a similar scenario. The potential for an upside exists if case numbers decrease and local leaders start reopening economies in anticipation of vaccination progress. While I can’t predict the rollout rate of vaccines yet, my expectation is that fewer governments will introduce restrictive measures as the vaccination process advances, leading to a recovery for economies and communities. Will this recovery occur in our fourth quarter? I hope so. But realistically, I believe it's more likely to happen by next summer. That's my personal perspective on the situation.
Operator, Operator
We'll take our next question from Shlomo Rosenbaum with Stifel.
Shlomo Rosenbaum, Analyst
Sorry, I’m on mute. Thank you for pointing that out. I just have a few things to discuss. It's been great here, thank you. I have a few housekeeping items that might be helpful to run through. Can you provide more detail on the transition from one-time sales to subscription sales? Can you elaborate on how this impact might have manifested during the quarter and the success you're experiencing? Is this a more permanent improvement? I have a couple more questions after that.
Todd Schneider, COO
Shlomo, this is Todd. In our latest quarterly release, we mentioned that when customers, such as government school systems or healthcare providers, purchase large orders of PPE, they typically take a significant amount initially and then shift to a maintenance mode. We had some large orders in Q1 and a few in Q2; many of those customers from Q1 are now in maintenance mode and did not make purchases in Q2. It’s a diverse situation, and predicting how long these customers will need those products and services in this dynamic market is challenging. That’s why we have made significant investments in inventory levels to assist our customers. I hope this provides you with some additional insight.
Shlomo Rosenbaum, Analyst
Okay. And then, Hey, Mike, this is for you, I knew you were really good with numbers, but I'm still trying to figure out how you got an 18 million get dollar gain pre-tax on 108 million shares to be $0.025 of VPS that trigger some other kind of, tax benefit or something with that gain of sale.
Todd Schneider, COO
It's a great question, Shlomo. Yes, the assets had a high tax basis and while there was a book gain, it resulted in a tax loss. You can think of it this way: the $18 million pre-tax gain translated to about a $0.12 benefit, while the tax benefit equated to roughly a $0.013 benefit. In other terms, the 13.3% tax rate was positively impacted by approximately 270 basis points, or 370 basis points from these transactions. The remainder of that tax rate would be around 17%. Without that benefit, there was still some influence from equity compensation, as we have discussed previously. Regarding the tax rate moving forward, I would suggest considering a range of 20% to 21% for the third quarter.
Operator, Operator
Thank you. That concludes today's question-and-answer session. Mr. Adler, at this time, I will turn the conference back to you for any additional or closing remarks.
Paul Adler, Vice President, Treasurer and Investor Relations
Well, thank you, everyone for joining us. We will issue our third quarter of fiscal '21 financial results in late March. We look forward to speaking with you again at that time. Good day.
Operator, Operator
This concludes today's call. Thank you for your participation. You may now disconnect.