Earnings Call Transcript - CTAS Q3 2023

Operator, Operator

Good day, everyone, and welcome to the Cintas Corporation Announces Fiscal 2023 Third Quarter Earnings Release 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 F. Adler, Vice President, Treasurer and Investor Relations

Thank you, Ross, and thank you for joining us. With me is Todd Schneider, President and Chief Executive Officer; and Mike Hansen, Executive Vice President and Chief Financial Officer. We will discuss our fiscal 2023 third quarter results. After our commentary, we will open the call to questions from analysts. 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 Securities and Exchange Commission. I'll now turn the call over to Todd.

Todd M. Schneider, President and CEO

Thank you, Paul. Third quarter total revenue grew 11.7% to $2.19 billion. Each of our businesses continue to execute at a high level. The benefit of our strong revenue growth flowed through to our bottom line. Excluding a gain in the related tax benefit in last year's third quarter, operating income margin increased 110 basis points to 20.4% and diluted EPS grew 16.7% to $3.14. I thank our employees whom we call partners for their continued focus on our customers, our shareholders, and each other. The Uniform Rental and Facility Services operating segment revenue for the third quarter of fiscal 2023 was $1.72 billion compared to $1.55 billion last year. The organic revenue growth rate was 10.8%. While price increases contributed at a higher level than historically, revenue growth was driven mostly from increased volume. Our sales force continues to add new customers and penetrate and cross-sell our existing customer base. Businesses prioritize all we provide including image, safety, cleanliness, and compliance. Our First Aid and Safety Services operating segment revenue for the third quarter was $231.6 million compared to $213 million last year. The organic revenue growth rate was 7.8%. The segment was up against a difficult revenue comparison because last year's third quarter revenue included about $15 million in sales of COVID-19 test kits that did not repeat this year. Excluding the prior year test kit sales, the organic revenue growth rate was 16%. We continue to have good momentum in our First Aid Cabinet business, which continues to grow greater than 20%. Health and safety of employees remains top of mind. We provide businesses with access to quick and effective products and services that promote health and well-being in the workplace. Our Fire Protection Services and Uniform Direct Sale businesses are reported in the all other segment. All other revenue was $242.2 million compared to $194.3 million last year. The fire business revenue was $155.8 million and the organic revenue growth rate was 20.7%. Uniform Direct Sale business revenue was $86.5 million and the organic growth rate was 32%. Now before turning the call over to Mike to provide details of our third quarter results, I'll provide our updated financial expectations for our fiscal year. We are increasing our financial guidance. We are raising our annual revenue expectations from a range of $8.67 billion to $8.75 billion to a range of $8.74 billion to $8.80 billion. The total growth rate of 11.3% to 12%. Also, we are raising our annual diluted EPS expectations from a range of $12.50 to $12.80 to a range of $12.70 to $12.90, a growth rate of 12.6% to 14.4%. Mike?

J. Michael Hansen, Executive Vice President and CFO

Thanks, Todd, and good morning. Our fiscal 2023 third quarter revenue was $2.19 billion compared to $1.96 billion last year. The organic revenue growth rate adjusted for acquisitions and foreign currency exchange rate fluctuations was 11.8%. Gross margin for the third quarter of fiscal 2023 was $1 billion compared to $898.2 million last year, an increase of 15.1%. Gross margin as a percent of revenue was 47.2% for the third quarter of fiscal 2023 compared to 45.8% last year, an increase of 140 basis points. Energy expenses comprised of gasoline, natural gas, and electricity were a tailwind, decreasing 15 basis points from last year. Strong volume growth from new customers and the penetration of existing customers with more products and services helped generate great operating leverage. Gross margin percentage by business was 47.1% for Uniform Rental and Facility Services, 51.6% for First Aid and Safety Services, 48.5% for Fire Protection Services, and 35.8% for Uniform Direct Sale. Operating income of $446.8 million compared to $407.6 million last year. Operating income as a percentage of revenue was 20.4% in the third quarter of fiscal 2023 compared to 20.8% in last year's third quarter. Fiscal 2022 third quarter operating income included a $30.2 million gain on an equity method investment transaction. The gain was recorded in selling and administrative expenses. Excluding this gain, fiscal 2023 third quarter operating income as a percentage of revenue was 20.4% compared to 19.3% in last year's third quarter, an increase of 110 basis points. Our effective tax rate for the third quarter was 22.1% compared to 18.2% last year. The fiscal 2022 third quarter equity method investment transaction included a significant tax benefit. Excluding the transaction, the effective tax rate for the third quarter of fiscal 2022 was 19.6%. Net income for the third quarter was $325.8 million compared to $315.4 million last year. This year's third quarter diluted EPS of $3.14 compared to $2.97 last year. However, fiscal 2022 third quarter diluted EPS contained $0.28 from the gain on the equity method investment transaction, which included a related $0.07 tax rate benefit. Excluding this gain and the related tax benefit, fiscal 2023 third quarter diluted EPS of $3.14 compared to $2.69 in last year's third quarter, an increase of 16.7%. Cash flow remains strong. On December 15, 2022 we paid shareholders $117.4 million in quarterly dividends, an increase of 18.6% from the amount paid the previous December. Todd provided our annual financial guidance related to the guidance, please note the following: fiscal 2022 included a gain on sale of operating assets in the first quarter and again on an equity method investment in the third quarter. Excluding these items, fiscal 2022 operating income was $1.55 billion, a margin of 19.7%, and diluted EPS was $11.28. Please see the table in our earnings press release for more information. Fiscal 2023 operating income is expected to be in the range of $1.77 billion to $1.80 billion compared to $1.55 billion in fiscal 2022 after excluding the gains. Fiscal 2023 interest expense is expected to be $112 million compared to $88.8 million in fiscal 2022, due in part to higher interest rates. Our fiscal 2023 effective tax rate is expected to be 20.7%. This compares to a rate of 17.9% in fiscal 2022 after excluding the gains and their related tax impacts. Our financial guidance does not include the impact of any future share buybacks, and we remain in a dynamic environment that can continue to change. Our guidance contemplates a stable economy and excludes significant economic disruptions or downturns. I'll turn it back over to Paul.

Paul F. Adler, Vice President, Treasurer and Investor Relations

And that concludes our prepared remarks. Now we are happy to answer questions from the analysts. Please ask just one question and a single follow-up if needed. Thank you.

Operator, Operator

Our first question comes from Manav Patnaik from Barclays. Please go ahead, Manav.

Manav Patnaik, Analyst

Thank you. Good morning. Could you discuss your strong results from the quarter? I'm assuming the trends you’re hearing from your customers were positive. However, have you noticed any recent changes, particularly in light of the recent events in the banking sector, and is that affecting small business confidence where you have more exposure?

Todd M. Schneider, President and CEO

Good morning Manav. Thanks for the question. We're watching it very closely. Certainly, there's rumblings when you read the newspapers every day and what's going on in the marketplace, but our customers seem still quite solid. And it's always a very competitive marketplace, and we're competing quite well there. They like our products and services, and we help them run their business better. So we like our value proposition, but we certainly prefer an environment where our customers are in a great strong economy. But we're not seeing it just yet. And we're certainly watching it very closely and monitoring it and making sure that we're focused on providing great value for our customers.

Manav Patnaik, Analyst

Got it. And then just as a follow-up, the growth has obviously been pretty strong, better than I think what we were expecting to, but you said most of that growth was mostly volume. And so I was just wondering on the volume piece, is it that you're taking maybe more share than normal? Or is it just that these businesses are starting to get back to more normal capacity, and so there's more of that volume recovery that's aiding that?

Todd M. Schneider, President and CEO

Yes, it's a good question. There's a whole lot of inputs to our success in growing our revenue at the levels that we're growing at, and it is exceeding our expectations. Certainly, new business is quite good. We really like that. Our retention levels are very attractive. Cross-sell that we've spoken about in the past is continuing to improve. And as we mentioned, pricing is above historical, but the volumes are really coming from the three areas that I mentioned. Keep in mind, the majority of the new accounts that we sell are new to our segment, meaning we call them new programmers, so we're growing the pie, not just taking share. We certainly love to do both, but growing the pie has been something that we are quite good at and have done consistently over the years, and we still think the future is quite bright there.

Operator, Operator

And our next question comes from Andrew Steinerman from JPMorgan Securities. Please go ahead, Andrew.

Andrew Steinerman, Analyst

Hi. Without just one quarter left in the fiscal year, I just wanted to ask what the organic revenue growth year-over-year for the fourth quarter 2023 is implied in the upgraded fiscal 2023 guide?

J. Michael Hansen, Executive Vice President and CFO

Andrew, the fourth quarter guide would contemplate 6.5% to 9.5% revenue growth. But keep in mind, we've talked a lot about the direct sale business, which grew 32% in the third quarter, and it is coming up against tougher comps. And so we just don't see that kind of growth continuing and settling back into what we would say is a typical growth rate for direct sale in that low single digits. So that's the primary change that we see in the fourth quarter.

Andrew Steinerman, Analyst

Right. And so for the rental business, you're expecting a similar growth rate in the fourth quarter than you had in the third?

J. Michael Hansen, Executive Vice President and CFO

Well, I'll say this, Todd just talked about the fact that we haven't seen much change in customer behavior, and the demand has still been really good. The momentum in the rental business is strong. While I'm not ready to provide a specific number, we don't anticipate much change as we move into the fourth quarter. Momentum remains strong.

Operator, Operator

And our next question comes from Faiza Alwy from Deutsche Bank. Please go ahead, Faiza.

Faiza Alwy, Analyst

Yes, good morning. I wanted to discuss how your results have historically outperformed expectations, particularly with the new verticals and their benefits during implementation. I'm curious about the potential for additional run rate in those areas as we approach the next fiscal year.

Todd M. Schneider, President and CEO

I'll start, and then Mike can certainly chime in. Our results are quite good, and we generally grow at rates higher than GDP. We are pleased with our current position and our future direction. When it comes to SAP, we are at the beginning stages. This encompasses our technology investments and the digitization of our business. We have completed various implementations, and while there is always more work to do, we are already experiencing benefits from our technology investments. Our customers are also seeing advantages, which enhance our competitive edge in the market. We have mentioned before the specific benefits we gain from technology investments, such as the Cintas portal, which is a clear advantage for our customers. They can manage their accounts and submit requests mostly outside regular business hours. Our customers prefer this flexibility, allowing them to conduct business at their convenience and delegate tasks to us. This portal provides them with that flexibility, which is reflected in improved customer satisfaction and loyalty. We are still very much in the early stages of deploying our technology.

J. Michael Hansen, Executive Vice President and CFO

Before you continue, Todd, I want to remind you that we really value the market opportunity for our business. We see it as a very significant chance for growth. To put it another way, while we currently have just over 1 million customers, there are 16 million businesses in the U.S. and Canada. We want to emphasize how great this market opportunity is. Todd mentioned that most of our new business is coming from expanding our served market or reaching that vast market potential, which indicates that we can grow at rates that exceed GDP and employment growth for an extended period. It's important to keep this in mind as you consider our long-term growth potential, as the market opportunity is substantial.

Faiza Alwy, Analyst

That's really helpful. I would love to hear more about the technology, so I'll leave it up to you regarding how much you'd like to share. Specifically about the healthcare vertical, could you discuss the growth trends there, what they were like in this particular quarter, and how they have been trending?

Todd M. Schneider, President and CEO

Certainly, the healthcare business is a significant area for us. We have dedicated years to organizing effectively with our service providers and sales partners, aligning our products and services to what they find appealing. A great illustration of this is our notable growth rates, which exceed our overall performance. This success is largely due to the strategies I mentioned, as well as some specific products we have recently introduced. For instance, our scrub business, which previously was not very appealing, has transformed since we launched our garment dispensing service. This service effectively manages inventory levels for our clients. The pivotal advantage is that the technology regulates what each individual can access, allowing us to offer higher quality products while avoiding the pitfalls of low-cost, low-margin items. Our customers are more satisfied, and we manage costs much more effectively due to controlled inventory. This stands out as a prime example of our innovations in the healthcare sector. This technology is highly valued, and it's driving attractive growth in that business. We are still in the early stages of this development. I hope this provides you with a clearer understanding.

Operator, Operator

And our next question comes from George Tong from Goldman Sachs. Please go ahead, George.

George Tong, Analyst

Hi, thanks, good morning. I wanted to dive a little bit more into the selling environment. Can you discuss what you're seeing with client sales cycles, budgets, and client headcount and what the implications are for the business?

Todd M. Schneider, President and CEO

Yes, thank you for the question, George. I would say that the selling environment remains quite similar and hasn't changed much. Sales cycles are not lengthening, and our customers are still focused on bringing in the right talent to ensure they deliver adequate service. In such environments, we add value to their operations. We help them run their businesses more efficiently, and in many cases, we assist customers in saving money compared to their previous strategies. Earlier, I mentioned that when we engage with a customer who is not a programmer, they often have independently procured products and struggle to manage those solutions. Because of our scale, sourcing capabilities, and our existing service relationship with them, we can offer significant value and even help reduce their costs. Generally speaking, George, I would say the selling environment has remained pretty consistent with little change over the last six months.

George Tong, Analyst

Got it. That's helpful. And as a follow-up, you increased your full year guidance pretty much across the board. How much of that increase was driven by fiscal 3Q outperformance versus your internal expectations compared to a stronger fiscal 4Q outlook?

J. Michael Hansen, Executive Vice President and CFO

George, I don't know if I can specifically separate the guidance raise. But clearly, we had a nice third quarter and the performance was strong from the organic growth to the gross margins to the operating margin. So a pretty solid quarter all the way through. And our guide for Q4 would suggest we expect more of the same. So the guide would suggest we expect another nice quarter. Hard to separate though for us exactly what the difference is because our internal expectations are a little bit different than our external, I'll say, consensus and guide.

Operator, Operator

And our next question comes from Stephanie Moore from Jefferies. Please go ahead, Stephanie.

Hans Hoffman, Analyst

Hi, this is Hans Hoffman on for Stephanie. Thanks for taking my question. Just wanted to ask on margins, specifically the First Aid and Safety gross margin. Obviously, really strong and almost 52%. Is that just a function of kind of lower margin PPE sales rolling off and higher-margin cabinets business kind of becoming a larger part of the mix or is there anything else kind of to call out on the performance there and how should we be thinking about margins in that business on a go-forward basis?

Todd M. Schneider, President and CEO

Yes, Hans, it's a good question and good morning. We are very pleased with the trends we're observing in the gross margin of the First Aid business, and overall, we are satisfied with the First Aid segment. The execution is at a very high level. We are benefiting from a favorable mix, as PPE and safety sales typically have lower margins, yet there is strong demand for our offerings. Health and Wellness is connecting well with the market. Our guiding principle in that area is the importance of health and safety for businesses. This resonates well, allowing us to gain good leverage from growth and mix. Strong execution is key, and we are pleased with our operations in that segment.

Hans Hoffman, Analyst

Got it, thanks. For my follow-up, I wanted to ask about the all other segment. There was clearly strong growth in that area this quarter. Last quarter, you mentioned expecting tougher comparisons, particularly in the Uniform Direct business for the second half of this year. I'm curious about what contributed to the strong performance this quarter, as many of us thought it would appear in Q3.

Todd M. Schneider, President and CEO

Yes. Certainly, the comps in Q4 are quite challenging and as Mike mentioned, we do expect that to moderate. The Uniform Direct Sale business is a little lumpier and sometimes, things come through based upon customer demand a little faster or what have you. But certainly, the comps in Q4 are tougher, and that's part of our guide.

Operator, Operator

Our next question comes from Andrew Wittmann from R.W. Baird. Please go ahead Andrew.

Andrew Wittmann, Analyst

Yes, great, thanks. Good morning everyone. Mike, could you discuss some of the inflationary factors that are impacting the overall economy? Specifically, I'm interested in the costs of goods sold or merchandise costs related to uniforms, mats, and the additional services you offer. Also, could you update us on labor progress in your business? Have you been able to leverage those costs despite the challenges? In other words, are those costs down as a percentage of revenue this quarter? Please share any trends you are observing, including whether there is any moderation or acceleration in these costs.

J. Michael Hansen, Executive Vice President and CFO

Sure. I'll begin with material costs. We source over 90% of our volume directly, and more than 90% of our items come from multiple sources. This is crucial because it gives us options when our vendors face inflation. While we may have to accept some price increases, we often have room to negotiate and adapt, so we are not obligated to accept every increase. Our ability to direct our sourcing and have multiple suppliers is significant. Additionally, the way we amortize these expenses allows us to anticipate future costs. When a vendor raises prices, it takes time for us to build up inventory, distribute it to our centers, and then have it available for rental. In the first month, we might experience only a small fraction of the inflation, which provides us with a good lead time for planning. This allows us to consider various initiatives and implement process improvements, potentially initiating price increases before the full inflation hits. This setup enables us to plan without significant disruptions. Furthermore, we have substantial infrastructure, including facilities, trucks, and rents, which are not as immediately affected by inflation. This means our growth gives us leverage in these areas of our cost structure. Regarding labor, we aim to maintain strong partner engagement, ensuring our rates are competitive. Over the last six years, we've realized synergies that have allowed us to be more proactive in raising rates. This preparation has helped us manage labor challenges effectively, minimizing disruptions. Additionally, initiatives like Smart Truck and technology improvements in our facilities enhance our efficiency, allowing us to grow without needing many additional resources, which helps us manage labor costs even as rates rise.

Todd M. Schneider, President and CEO

Mike, if I can add, Andrew, certainly, in this type of inflationary environment, it's challenging to grow gross margin. We've been quite successful in doing so. Getting good leverage on that revenue has been key for us. But managing our variable costs, that's simply part of our culture, managing it very, very closely. So that's been big. But to Mike's point, leveraging some of our digital transformation, Smart Truck has been very important to us. And then also managing our inventory at our used stock rooms has been really important. And we have good systems in place there that allows us to get better reuse, which is better for the customer because the speed at which we can provide products goes up because it's right there available locally, don't have to get it from a distribution center and ship it into us. And it also, obviously, helps the amortization schedule when you can get better reuse of that current product that you're already paying for. So, the leverage that we're getting as a result of the systems and processes we put in place with technology have been paying off.

Andrew Wittmann, Analyst

That's helpful. For my follow-up, I wanted to ask about the balance sheet, Mike. In the next quarter or two, you'll be at about one times leverage, which is on the lower end of where you've historically run the company. With the company generating about $2.2 billion in EBITDA and growing, there is strong cash flow. You will have not only the ability to leverage the balance sheet but also good cash coming in, providing significant capital to deploy. How do you plan to deploy that capital in a situation where we haven't seen that level of capital deployment since you acquired G&K six years ago? How will you keep the balance sheet properly geared, and what opportunities do you see out there?

J. Michael Hansen, Executive Vice President and CFO

The most important aspect for us is to ensure we are investing correctly for the long-term success of the business. We aim to grow our capacity in alignment with our growth, provide training for our partners, and take the necessary actions for sustainable long-term growth. We still have a strong desire to pursue acquisitions, although it is difficult to predict when these may occur. We recently increased our dividend by nearly 20% this past year. While we did not engage in any buybacks last quarter, that remains a potential avenue for us moving forward. We want to be cautious with our cash investments, which may sometimes result in taking longer to deploy funds. Ultimately, our primary focus is the long-term growth of the business, both in revenue and profit, and ensuring we are undertaking the right initiatives to achieve that while also exploring prudent opportunities for enhancement.

Operator, Operator

And our next question comes from Tim Mulrooney from William Blair. Please go ahead Tim.

Samuel Kusswurm, Analyst

Hey, this is Sam Kusswurm on for Tim. Thanks for taking my questions here. I guess to start on the margin side, lower energy costs were a 15 basis point benefit during the quarter. I'd imagine this dynamic is going to continue for the next few quarters. I was wondering if you could help frame for us the pacing and size of any benefit you're expecting, if you have any color to provide there?

Todd M. Schneider, President and CEO

Well, certainly Sam, we watch the energy prices very closely. Fuel, as in diesel and gasoline, hasn't changed that much year over prior. Natural gas, we're watching, and we expect that, that will be a benefit in the near future and the electricity it doesn't change a whole lot. So I wouldn't say that you can count on significant tailwind there. We are certainly not when you think about energy as a percent of sales, I think we came in at 2.15% energy as a percent of sales. So we like when they're coming down, and we manage it as they're going up, but I wouldn't expect a real change there.

J. Michael Hansen, Executive Vice President and CFO

Yes, just to frame it a little bit, Sam. Last year in the fourth quarter, our total energy was 2.5% of revenue. In the first quarter, it was 2.4%. This time, it was 2.15%. So we may see a little bit of a benefit in Q4 and Q1. But boy, we've worked so hard to get this to be such a small part of our cost structure that I'm not sure the benefit is going to be that significant one way or the other.

Samuel Kusswurm, Analyst

Got you. I appreciate the color there. I guess for a follow-up, you've spoken before about Smart Truck and I think you just mentioned the question previously for the riding software. Now it's been over a year since kind of for filling it out. I guess I'd be curious if you could help quantify a benefit to your margins and if you still think there is a sizable benefit remaining there from further durations or adoption?

Todd M. Schneider, President and CEO

Yes, great question, Sam. We definitely see ongoing opportunities with Smart Truck. We are very cautious when it comes to rerouting our existing customers because changing their service provider can lead to complications, as they often have a strong preference for their current provider. Therefore, we approach it carefully. I expect to see benefits in this area for many years to come. This impact will be evident in energy savings, emissions reductions, and increased productivity, as our partners will have more time to focus on their customers and deliver greater value. It's important to note that we only generate revenue when the wheels stop moving, so we prioritize that. I believe you will notice these benefits for years ahead.

Operator, Operator

And our next question comes from Seth Weber from Wells Fargo. Please go ahead Seth.

Seth Weber, Analyst

Good morning, Mike. I wanted to ask about free cash flow. It was slightly below our expectations for the quarter. Do you think this is just a temporary result of revenue growth not keeping pace, leading to some delays in working capital? Could you explain your outlook on working capital moving forward? Thank you.

J. Michael Hansen, Executive Vice President and CFO

Free cash flow is a valid concern. We're coming off a fiscal 2021 year with limited growth, but we're experiencing some strong momentum heading into fiscal 2022 and 2023. After utilizing capacity during the pandemic, we now find ourselves needing additional capacity. We've managed this effectively through various means, including improving efficiency in our existing wash alleys, adding washers and dryers, and possibly constructing new facilities. It’s time to increase our capacity again, which is a positive sign. However, there is a slight delay in our capital expenditures, and we are catching up. We do expect free cash flow to remain very strong. As our business grows, we will utilize some working capital, which is typical. We anticipate that our capital expenditures will align more closely as we move into the next year and beyond, provided there are no further economic disruptions.

Seth Weber, Analyst

Okay, that's helpful. Do you think CAPEX could return to the 4% of revenue range that it was at towards the end of the last decade, or has it dropped to around 2% a couple of years ago? I'm just trying to understand where we stand.

J. Michael Hansen, Executive Vice President and CFO

Yes, it's going to be close. We certainly don't expect it to be down at the 2% level. It's going to be closer to the 4% level as we think about moving forward.

Operator, Operator

And our next question comes from Heather Balsky from Bank of America. Please go ahead Heather.

Heather Balsky, Analyst

Hi, thank you. You talked a fair amount during the call about your success with new customers and that a lot of them are what you call non-programmers. And I think a key theme that's been discussed on multiple calls is the shift to outsourcing and an acceleration kind of in that trend. I'm just curious, as you kind of look to what happened in the third quarter and as you're looking out, kind of your thoughts on how that trend continues, do you see it normalizing, or do you think there's further momentum into the next few years? Thanks.

Todd M. Schneider, President and CEO

Yes, good morning Heather. I'd say that trend continues. There are still 10 million job openings, and our customers are trying to attract talent while running their businesses and providing the expected levels of service. When we can outsource tasks for them at very competitive rates, it becomes quite appealing, especially since we're already in those markets. It’s often a relief for them to have us handle those responsibilities. We plan to continue leveraging this model. Regardless of economic conditions, customers need to take care of their own clients, and we can assist them in doing that. Our focus will be on delivering value while managing our cost structure to maintain competitive pricing.

Heather Balsky, Analyst

Great, thank you. And I guess as my follow-up, you discussed earlier that you are looking for M&A opportunities, although you don't know kind of when those might occur. I'm curious, can you talk about your priorities with regards to M&A, are there white space areas you want to fill in, is it geographic opportunities, just what are your priorities? Thanks.

Todd M. Schneider, President and CEO

Yes, good question, Heather. So we're interested in M&A, certainly in our rental business, in our First Aid business, and our Fire business. And we make acquisitions every year, every quarter, it seems in each of those businesses. But they're usually reasonably small. Some of them are geographic expansion, some of them are tuck-in. So it's a real mixture. And M&A tends to ebb and flow a bit. It's tough to predict timing, but we're interested in M&A in all those businesses. They have to be the right businesses, meaning well-run businesses, but large, medium, small, we are interested in all and each of those businesses.

Operator, Operator

And our next question comes from Toni Kaplan from Morgan Stanley. Please go ahead Toni.

Toni Kaplan, Analyst

Thanks so much. Wanted to ask about your staffing right now, are you being more cautious now because of the environment or not because I know you mentioned you haven't really seen a slowdown yet in your customer base. So maybe nothing has really changed, so I just wanted to think about how you're thinking of staffing going forward?

Todd M. Schneider, President and CEO

Yes, Toni, today. The labor market in general is easier than it was six months ago. It's certainly not easy still. And so we're focused on staffing at the level to make sure that we provide really good customer service. And so that's where we are. We will adjust accordingly if the economic cycle changes. And we're watching it really closely, as you can imagine, to make sure that we're providing the right service, the right value to our customers. But we certainly have a watchful eye out to understand if demand starts to change based upon what's going on in the broader economy.

Toni Kaplan, Analyst

Terrific. I wanted to ask about pricing. You mentioned several times during the call that price played a larger role this quarter compared to previous periods. I would like to understand if this is because you have been raising prices a lot and are now maintaining that level, or if the rate of price changes is still higher than before, or if it's simply the effect of previous price increases continuing to show results. Thanks.

Todd M. Schneider, President and CEO

Yes, Toni. Our pricing varies because it is determined locally, so we approach it differently across various businesses and regions. Our pricing is higher than it has been historically, but the main driver of our growth is volume. The current inflationary environment requires us to implement larger price increases than we typically would. Fortunately, our customers are aware of the situation and appreciate the level of service we provide, which makes them receptive to these adjustments. While we won't provide guidance beyond Q4, if the Federal Reserve's actions successfully reduce inflation, we will adjust our business strategies accordingly.

J. Michael Hansen, Executive Vice President and CFO

Toni, I want to clarify that the pricing Todd mentioned earlier is in comparison to historical levels. We weren't indicating a sequential increase in pricing. If that was the basis of your question, it's important to note that while we are above historical pricing levels, there hasn't been a significant sequential change.

Operator, Operator

And the next question comes from Shlomo Rosenbaum from Stifel. Please go ahead Shlomo.

Shlomo Rosenbaum, Analyst

Hi, thank you very much. I want to ask back on kind of the questions Manav was asking about initially. Just in terms of the client base that you have, it's interesting like the ADP National Employment Report is talking about small businesses have been shedding jobs basically since August. Are you not seeing that at all in your client base or is it that you just skew more towards midsized and larger clients, I just want to get a little bit further into how to read some of the kind of economic reports versus the very strong results that we're seeing at Cintas?

Todd M. Schneider, President and CEO

Thank you for your question, Shlomo. We have a very diverse customer base that includes small, medium, and large clients across various geographies and industries. Our business is currently more focused on the service economy rather than just goods production. We serve a mix of small customers, some of whom are struggling and others that are doing well, which largely depends on their specific circumstances. The same applies to our medium and larger customers. We adapt our approach when a customer is facing challenges, adjusting our services based on their changing demand. Additionally, we offer products and services that can provide cost savings to our customers. Our focus remains on delivering value, and we intend to continue that commitment.

Shlomo Rosenbaum, Analyst

Okay, great and then just following up on Toni’s question on the pricing, is there any change at all in customer behavior in terms of the continued pricing, is there any more pushback or its kind of the same that you have had over the last say two to three quarters?

J. Michael Hansen, Executive Vice President and CFO

Yeah, well there is always pushback from customers, always has been and always will be. The current environment with inflation levels makes it an opportunity for us to do so better than historical, larger than historical. But I wouldn’t tell you that the environment has changed dramatically. But certainly inflation appears to be starting to come down and so we are managing our business accordingly, and we will manage our customers accordingly as well.

Operator, Operator

And the next question comes from Scott Schneeberger from Oppenheimer. Please go ahead Scott.

Scott Schneeberger, Analyst

Thanks, good morning everyone. Regarding the focus on margin, could you provide some attribution? A 110 basis points improvement in operating income year-over-year is impressive. Can you detail what contributed to this improvement in the top line versus the efficiencies realized on the cost side? Additionally, could you elaborate on the contributions from Smart Truck, automation in the facilities, and SAP? I'm particularly interested in where you're currently seeing the most benefit on the cost lines. Thanks.

J. Michael Hansen, Executive Vice President and CFO

The growth is strong, and when our top line grows at healthy levels, we experience significant leverage. I've mentioned before that with certain costs related to infrastructure, strong growth allows us to achieve great leverage across all our businesses. The growth we experienced in the third quarter was widespread across all four sectors, leading to notable leveraging in each. I also touched on the amortization of material costs, particularly in the rental sector, which helps us anticipate changes and plan effectively. This growth not only aids in that respect but also prompts us to consider process improvements, like the Smart Truck initiative you referenced. We have various initiatives underway in each of our businesses, and we are diligently working on them. We're seeing advantages from process improvements, which range from enhanced training to technology-driven solutions like Smart Truck. Each business is benefiting from these efforts. For instance, in the First Aid segment, the margin increased from 12.4% last year to 20.4% this year, benefiting from an improved product mix, better sourcing, and various process improvements, including Smart Truck. While I can't provide specific figures, it all begins with significant growth and leverage, followed by better sourcing, process enhancements, technology advancements, and a healthy mix—each contributing to our success.

Todd M. Schneider, President and CEO

Scott, I’d like to emphasize that, as Mike mentioned, our growth is fundamental to our success. A key part of our culture is addressing inefficiencies within our business. There are many factors that contribute to revenue growth and margin enhancement, and Mike has covered a thorough list. Overall, we are committed to improving without solely relying on pricing increases. In these challenging inflationary times, we are determined to eliminate inefficiencies to enhance our margins. The team is doing an excellent job, and we take great pride in that.

Scott Schneeberger, Analyst

Sounds good, I appreciate the overview. Sounds like a lot of good momentum. You all touched upon My Cintas portal earlier. It sounded like maybe a little bit more you're willing to share. Just curious what percent penetration do you have there, where do you anticipate that to go? And you mentioned that gets used at all hours of the day, but I'm just wondering what inning are we in, and any quantification of benefit of if customers are using that, how much more is that efficient in financially if there's anything you can share on that? Thanks.

Todd M. Schneider, President and CEO

Yes, absolutely, Scott. You're referring to changes in customer behavior. A higher percentage of new customers are engaging at a significant level because they are adopting new behaviors. However, altering the behavior of existing customers takes longer, as they are accustomed to our previous methods, and some are adapting more quickly than others. We believe there is a long-term opportunity for benefits here. These benefits manifest in various aspects, particularly in our efforts to make it easier for customers to engage with us. I believe you will see these advantages for many years to come.

J. Michael Hansen, Executive Vice President and CFO

It's an evolution with My Cintas where customers begin to use it and appreciate the benefits. As they grow in their usage, we can introduce more options and features that will expand over time. This isn't just a switch we flipped on My Cintas and now we wait to see how many customers adopt it. Instead, we've launched it, and the product will continuously grow and create more opportunities for us. We will see an increase in customers and additional functionality in the future. As Todd mentioned, this is a journey and an evolution, and we are just beginning.

Operator, Operator

And at this time, there are no further questions. I'd like to turn the call back over to Paul Adler for closing remarks.

Paul F. Adler, Vice President, Treasurer and Investor Relations

Okay, Ross. Thank you all for joining us this morning. We will issue our fourth quarter fiscal 2023 financial results in July, and we look forward to speaking with you again at that time. Good day.

Operator, Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.