Earnings Call Transcript - CTAS Q2 2024

Operator, Operator

Good day, everyone, and welcome to the Cintas Corporation Announces Fiscal 2024 Second Quarter Earnings Release Conference Call. Today's call is being recorded. At this time, I would like to turn the meeting over to Mr. Jared Mattingley, Vice President, Treasurer and Investor Relations. Please go ahead, sir.

Jared Mattingley, Vice President, Treasurer and Investor Relations

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 2024 second 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 discussions on these points contained in our most recent filings with the Securities and Exchange Commission. I will now turn the call over to Todd.

Todd Schneider, President and CEO

Thank you, Jared. We are pleased with our second quarter results and are excited about the future. Second quarter total revenue grew 9.3% to $2.38 billion. Each of our businesses continues to execute at a high level. Our momentum in the business is good and volume remains robust. We can grow in a number of different ways. Contribution to our growth from new business remained strong and comes from companies that either outsource their program today or they are managing it themselves. We continue to have great success cross-selling to existing customers. Retention levels are strong and remain at very attractive levels, and our value proposition of image, safety, cleanliness, and compliance continues to resonate across businesses of all sizes and in all verticals. We continue to be pleased with the results from our focus on prospects within the verticals of healthcare, hospitality, education, and state and local government. We recently announced the opening of two cleanroom facilities, one in North Carolina and the other in Wisconsin. These facilities will provide additional capacity in these regions in order to expand our efforts in this area of attractive growth from pharmaceutical and biotechnology companies. The benefits of our strong volume growth and revenue flowed through to our bottom line. Gross margin for the second quarter grew 11.6% and operating income grew 12.3%. Diluted EPS grew 15.7% to $3.61. Cash flow remained strong. Net cash provided by operating activities in the second quarter grew 17.8% over the prior year. Our strong cash flow gives us flexibility to choose how we deploy our capital. In the second quarter, we continued to invest in our businesses. We also acquired several smaller businesses. On December 15th, we paid shareholders $137.5 million in quarterly dividends, an increase of 17.1% from the amount paid the previous December. During the second quarter, we also purchased $320.3 million of Cintas common stock under our buyback program. I would like to thank our employees, whom we call partners, for their continued focus on our customers, our shareholders, and each other. Now, before turning the call over to Mike to provide details of our second 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 $9.40 billion to $9.52 billion to a range of $9.48 billion to $9.56 billion, a total growth rate of 7.5% to 8.4%. Also, we are raising our annual diluted EPS expectations from a range of $14.00 to $14.45 to a range of $14.35 to $14.65, a growth rate of 10.5% to 12.8%.

Mike Hansen, Executive Vice President and CFO

Thanks, Todd, and good morning. Our fiscal 2024 second quarter revenue was $2.38 billion compared to $2.1 billion last year. The organic revenue growth rate, adjusted for acquisitions and foreign currency exchange rate fluctuations, was 9%. Organic growth by business was 7.9% for Uniform Rental and Facility Services, 12.7% for First Aid and Safety Services, 17.8% for Fire Protection Services, and 4.7% for Uniform Direct Sale. Gross margin for the second quarter of fiscal 2024 was $1.14 billion compared to $1.02 billion last year, an increase of 11.6%. Gross margin as a percent of revenue was 48% for the second quarter of fiscal 2024 compared to 47% last year, an increase of 100 basis points. Strong volume growth and continued operational efficiencies helped generate this strong gross margin. Gross margin percentage by business was 47.4% for Uniform Rental and Facility Services, 54.5% for First Aid and Safety Services, 48.6% for Fire Protection Services, and 40.9% for Uniform Direct Sale. Gross margin for the Uniform Rental and Facility Services segment increased 40 basis points from last year. We continue to leverage our strong revenue growth and extract inefficiencies out of the business in order to expand margins. Our year-over-year improvements are no accident. Our Six Sigma and Engineering teams have helped us create efficiencies in the plant that allow us to maximize the utilization of our equipment, labor, and energy. Our SmartTruck technology allows us to improve our route efficiencies and provide density to our existing routes. While energy expenses comprised of gasoline, natural gas, and electricity were a tailwind of 40 basis points from last year, please keep in mind that some of the energy benefit is the result of efficiencies just mentioned. As an example, our rental revenue grew organically at 7.9%, but we only added 1% to our route structure since last year. Gross margin for the First Aid and Safety Services segment increased 400 basis points from last year. Our revenue growth is strong and our value proposition continues to resonate in this segment. The health and safety of employees remains top of mind. Our mix of revenues continues to be healthy, including growing high-margin recurring revenue products like AED rentals, eyewash stations, and WaterBreak. We continue to use technology like SmartTruck to optimize our routes and improve efficiencies. Additionally, our first aid dedicated distribution center allows us to lower product costs. All of these contribute to our improved margins. Selling and administrative expenses grew $64.4 million or 11.1% over last year. Strong revenue growth creates leverage, which allows us to invest in the business. We continue to invest in our people, adding selling resources, investing in our management trainee program to develop future leaders, and expanding our talent acquisition efforts. Operating income of $499.7 million compared to $444.9 million last year. Operating income as a percent of revenue was 21% in the second quarter of fiscal 2024 compared to 20.5% in last year's second quarter, an increase of 50 basis points. Our effective tax rate for the second quarter was 20.9% compared to 22.1% last year. The tax rates in both quarters were impacted by certain discrete items, primarily the tax accounting impact for stock-based compensation. Net income for the second quarter was $374.6 million compared to $324.3 million last year. This year's second quarter diluted EPS of $3.61 compared to $3.12 last year, an increase of 15.7%. Todd provided our annual financial guidance. Related to the guidance, please note the following. Fiscal 2024 interest expense is expected to be $100 million compared to $109.5 million in fiscal 2023, predominantly as a result of less variable rate debt. Our fiscal 2024 effective tax rate is expected to be 21.3%. This compares to a rate of 20.4% in fiscal 2023. The higher effective tax rate negatively impacts fiscal 2024 EPS guidance by about $0.16 and diluted EPS growth by about 120 basis points. Our financial guidance does not include the impact of any future share buybacks and guidance includes the impact of having one more workday in fiscal 2024 compared to fiscal 2023. This extra workday comes in our fiscal third quarter. I'll turn it back to Jared.

Jared Mattingley, Vice President, Treasurer and Investor Relations

Thanks, Mike. 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 Ashish Sabadra from RBC. Please go ahead, Ashish.

Ashish Sabadra, Analyst

Thanks for taking my question. Just on the four verticals that you highlighted as areas of strength in particular. I was wondering if you can quantify how big the combined revenues are from those verticals and how does the growth profile there compare to the company average? Any color? Thanks.

Todd Schneider, President and CEO

Good morning, Ashish. This is Todd. Thanks for the question. I don’t have a specific number for you regarding that exact figure, but I can tell you that our verticals are performing quite well. We're experiencing significant success. Our efforts to not only sell but also organize around these verticals are really paying off. I have a few accomplishments to share with you concerning these verticals. In healthcare, both acute and non-acute areas are doing well. We established a scrub rental program for a large hospital network in South Carolina, which has improved their consistency in branding and identification. The customer mentioned the importance of clearly identifying their personnel, and this new scrub program facilitated that. We had a similar outcome with a nursing home in Virginia, where the management wanted a consistent image for their staff. On the acute side, we implemented a new microfiber program at a hospital in Florida, addressing their challenges with inventory control and product quality, which were affecting cleanliness. Our program provided excellent products and technology to manage inventory efficiently, allowing them to concentrate more on patient care rather than managing microfiber issues. Additionally, we recently launched a first aid and AED rental program for a public library system in California. Although a public library might not seem like a typical prospect for us, they recognized the value of being prepared with AEDs for their employees, given the public activity at their locations. In the education sector, we have several wins to share. A chemistry department at a university in Virginia outfitted all their educators and students with lab tour uniforms. The maintenance department at a university in California switched all their staff to our Carhartt uniforms, and they love them. Lastly, at a university in Arizona, a dining facility has equipped all their culinary staff with Chef Works uniforms, which is a notable achievement. The partnerships with Carhartt and Chef Works have been significant successes. I didn’t want to go on too long, but I thought sharing these wins would be beneficial, given that verticals are of interest to you, Ashish, as well as to many others on the call.

Mike Hansen, Executive Vice President and CFO

Yeah. The only other thing I might add is, as Todd just talked about, we have so many ways to win, and clearly, those verticals are growing faster than the average. So we still are seeing really good momentum in each of those.

Ashish Sabadra, Analyst

That's great information, and I appreciate you sharing those events. It really provides more clarity on the verticals. If I could ask a quick follow-up, could you share any updates on your technology, specifically the SmartTruck program and the partnership with Google, Verizon, and SAP? Thank you.

Todd Schneider, President and CEO

Certainly. One of the key points we have here is that we don't generate revenue while our wheels are in motion. We actually make money when they come to a stop. As Mike mentioned, our overall company revenues grew by over 9%, while we only increased our route structure by 1%. This indicates that we are dedicating more time to our customers and less time on the road, which benefits our customers, our partners, and Cintas. We are satisfied with this development. Our technology still has significant potential for improvement. We are concentrating on enhancing efficiencies and eliminating inefficiencies in our operations. We issued a press release about our successful transition to the Google Cloud this quarter. There are several advantages to moving from a server farm to the Google Cloud. Firstly, it enhances our security, which is very crucial. Secondly, we anticipate it will be more cost-effective in the long run. Lastly, it provides us with access to Google's AI platform. Although we are in the early stages of this migration, we believe it will help us in the long term by improving the ease of doing business with Cintas and ensuring our team is well-positioned to succeed by utilizing these tools effectively.

Operator, Operator

And our next question comes from Manav Patnaik from Barclays Capital. Please go ahead, Manav.

Manav Patnaik, Analyst

Thank you. Todd, just to follow up on all the wins and contracts you talked about, maybe, I guess the question is more around the competitive environment versus is this just first time outsourcers? Any trends, any changes you're seeing from that front, the new business percentage you've called out before, but whether that's more market share or just first time outsourcing?

Todd Schneider, President and CEO

Good morning, Manav. That's a great question. As Mike mentioned, we have numerous ways of achieving success. Since the beginning of my career, we have been selling to non-programmers, and that continues to be the case. We service just over a million businesses, but there are 16 million businesses in the US and Canada, so there is ample opportunity. We appreciate both avenues of growth and do gain some market share from competitors. The examples I provided represent a mix; however, many of these businesses were either handling it internally by processing microfibers themselves or instructing their employees to purchase products. Various variations of non-programmers exist, such as those who would buy products and provide them for their staff or those who simply asked employees to come to work looking presentable. Regardless, we offer superior consistency in program identification, cleanliness, and compliance, which are significant factors for our customers.

Manav Patnaik, Analyst

Got it. And then just on the capital allocation front, I mean, the buyback number one of the bigger quarters for a while now. I mean, is that any indication of the M&A market slowing down or just how we should think about that balance there?

Mike Hansen, Executive Vice President and CFO

Manav, there hasn't been any change in what we're observing in M&A. We're continuing to work the pipeline as best we can and have made some nice acquisitions this year. Regarding our buyback, we've mentioned that it's an opportunistic execution, and that's evident in this quarter. Reflecting on our first quarter results, we felt they were quite good, although the stock reacted somewhat negatively, which we viewed as a good opportunity to take advantage of. This serves as a solid example of opportunistic execution for our buyback program. Furthermore, it's important to note that in terms of capital allocation, we don't always have to make a perfect choice for the quarter or year. We have been investing in the business as we discussed, with our CapEx increasing, which is significant for us. M&A spending is up from last year, and we've raised dividends by 17% compared to last year while successfully executing our buyback program. So, when we discuss the four levers of capital allocation, we've managed them all effectively this year. Additionally, the strength of our cash flow and balance sheet allows us the flexibility to make these choices without pressure.

Todd Schneider, President and CEO

Mike, I would just add that we think we're being really good fiduciaries of our shareholders' investments. Mike mentioned all the levers. And the net-net of that is we still have great dry powder, which allows us to take on M&A of all shapes and sizes and we're interested in that.

Operator, Operator

And our next question comes from Joshua Chan from UBS. Please go ahead, Joshua.

Joshua Chan, Analyst

Hi. Good morning. Thanks for taking my questions. So, Todd, you mentioned the opening of the cleanrooms. I was just wondering if you can kind of frame for us what you see as the attractive parts of this business. How is it attractive? And what kind of opportunity does it mean for Cintas going forward in the cleanrooms?

Todd Schneider, President and CEO

Thank you for the question, Josh. The cleanroom business is an appealing sector for us. I mentioned pharmaceutical and biotechnology companies, and it seems like there are increasingly more of them each year that require that level of cleaning and cleanliness. We believe this is a positive sign for the future of that business. Additionally, there has been noticeable momentum in bringing operations back to the U.S. in this area. We want to ensure that we have the right capacity to serve our current customers and are prepared for future demands. We appreciate the trends in this business and are optimistic about it.

Joshua Chan, Analyst

Great. Thank you for the color there, Todd. And, in fact, if I can follow up with the margin question, I guess, if in the future, the energy favorability were to lessen, could you talk to the opportunities that you still have to drive margin expansion and the targeted incremental margins going forward without as much energy tailwind?

Todd Schneider, President and CEO

We understand that energy prices fluctuate, but we are dedicated to identifying inefficiencies in our route structure and production facilities. This focus is crucial for us, and we see significant opportunities to improve. We've mentioned the impact of SmartTruck technology, which has been beneficial in many ways. Additionally, our Six Sigma team and engineering professionals, combined with this technology, give us unprecedented centralized visibility into our operations. This enables us to optimize our labor, equipment, and energy expenditures. While we appreciate when energy costs decrease, we are aware that market conditions will change, and our priority remains on eliminating inefficiencies to manage moving forward.

Operator, Operator

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

Heather Balsky, Analyst

Hi. Sorry about that. Thank you for taking my question. And first question with regards to the programmers and non-programmers, as we're further and further out from the COVID period, are you still seeing the shift in demand in terms of more non-programmers looking to outsource, or do you think it's starting to normalize back to pre-COVID trends?

Todd Schneider, President and CEO

That's a great question, Heather. I'll begin, and Mike can add his thoughts. There are several reasons why a prospect becomes a customer and transitions from not having a programmer to hiring one. One reason is the decision to outsource because they lack expertise or are having trouble finding qualified staff to manage the process. That trend continues. However, there are other reasons as well. For instance, they may be unhappy with the image they are projecting, or they might be concerned about compliance or identification issues. We can assure them of our hygienic standards. There are many motivations behind this. One key factor is the need for staffing support, which we are still observing. This enables our customers to concentrate on their core responsibilities, whether that involves serving their clients, patients, or guests, rather than managing these various programs.

Mike Hansen, Executive Vice President and CFO

Heather, more than 60% of our new business comes from no programmers. Regarding the pandemic, we certainly saw an increase in personal protective equipment and hand sanitizer in the early days. Those levels have since returned to what we consider normal and ongoing levels, so that might be the only change we experienced, and now we are back to normal.

Heather Balsky, Analyst

Thank you. Regarding margins, we are interested in understanding the sources of your anticipated savings. How much of this is due to organic Six Sigma efforts, how much is attributed to your SAP initiatives, and are there still synergies or opportunities from G&K that you're benefiting from? Thank you.

Todd Schneider, President and CEO

Heather, that's a good question. We don't really distinguish between our Six Sigma team, our Engineering team, and our Technologies; they all need to be coordinated effectively to achieve efficiency, and that's exactly what we're doing. Everyone needs to be involved, and that collaboration leads to great results. Regarding G&K, we've been about six and a half years since the acquisition, so I wouldn't say there's anything left to gain there.

Operator, Operator

And your next question comes from Andy Wittmann from RW Baird. Please go ahead, Andy.

Andy Wittmann, Analyst

Yeah, great. Thanks. Good morning, and thank you for taking my questions. I guess, I just wanted to ask on the outlook a little bit here, Mike. The second half total revenue guidance is in the 7% range at the midpoint against an organic 9% quarter here. So, a degree of deceleration. I guess that was implicit in your previous guidance as well. But just thought maybe give you a chance to elaborate a little bit more on that, talk about what you're seeing in the macro, if that's just you guys being kind of your normal prudent approach, or if there's something that we should be considering?

Mike Hansen, Executive Vice President and CFO

Andy, I would start by saying that we are taking our usual cautious approach. As we've mentioned, our growth remains strong, and we feel positive about the direction of the business. For the second half of the year, we anticipate a little over 7% growth at the midpoint and slightly more than 8% at the high end, which we find favorable. The trajectory looks promising. However, as we look ahead to 2024, there is some uncertainty regarding the potential impacts of the new economy and the Federal Reserve's actions, so we believe it is prudent to remain cautious as we plan for the future.

Andy Wittmann, Analyst

Great. That's my only question for today. Have a Merry Christmas, guys.

Todd Schneider, President and CEO

Thank you, Andy.

Operator, Operator

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

George Tong, Analyst

Hi. Thanks. Good morning. Earlier you mentioned that business momentum was good. Volumes were robust in the quarter. Can you provide more color on overall customer budget trends and customer sentiment, and any changes that you might be seeing in the sales cycle?

Todd Schneider, President and CEO

Good morning, George. As Mike mentioned, while we can't predict exactly how our customers will respond to the new calendar year, we have not observed any changes in sales cycles or in how our customer base is reacting to current market conditions. Business has remained consistent, and what Mike referred to regarding the transition into the new year is relevant. We will monitor how businesses respond following the holiday period.

George Tong, Analyst

Got it. That's helpful. And also you mentioned cross selling was good in the quarter. Can you elaborate more on cross selling trends that you're seeing, in which areas you're seeing most amount of bundling or upsell, cross sell from?

Todd Schneider, President and CEO

Cross selling is an important part of our growth, and we're seeing good success across all areas of our business. We are fortunate that our customers appreciate us and our relationships. Our teams are frequently present in their businesses, often on a weekly basis, which allows us to understand their needs and provide assistance. We adapt quickly based on what a customer is interested in and can help them in various ways. The size of our rental division means there are many customers, creating ample opportunities for our First Aid and Fire business to expand within that area. Overall, we're effectively collaborating across our organization, sharing leads and insights to ensure our customers receive excellent service.

Operator, Operator

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

Tim Mulrooney, Analyst

Yeah, good morning. I just wanted to ask one question. Pricing now normalized back to the 2% range. That means your organic growth was comprised of approximately seven points of volume. I was just hoping you could dig into that a little bit more as it was a little stronger than I think most of us were expecting. Did you see an uptick in retention? Did you have a strong quarter with that cross sell? Or maybe new account growth and any details would be helpful.

Todd Schneider, President and CEO

Good morning, Tim. Our new business is strong. As I mentioned, our retention levels are high and our cross-sell performance is impressive. Pricing is currently lower than last year, but it's higher than historical levels and is moving closer to them. Overall, our growth drivers are all performing well, and we anticipate this trend will continue.

Mike Hansen, Executive Vice President and CFO

And as we talk, we win in a lot of ways. And the momentum in the rental business is still really good. But we also saw in the quarter some really nice acceleration in First Aid and Safety from 11% in the first quarter to 12.7% organically in the second quarter. And we saw some nice improvement in Fire where we went from a little over 14% in the first quarter to 17.8% in the second quarter. So we just see some really good momentum in all of our businesses. And particularly those two had some really nice performance in the second quarter.

Tim Mulrooney, Analyst

Yeah, I did notice that re-acceleration across both those businesses. That's helpful color. Thanks, guys. Happy holidays.

Todd Schneider, President and CEO

Thank you, Tim. You as well.

Operator, Operator

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

Andrew Steinerman, Analyst

Hi. Could you just mention if your ad stops directionally and the uniform rental business was up, down, or flat recently?

Todd Schneider, President and CEO

Good morning, Andrew. Our ad stop metrics have been pretty consistent. We haven't seen much of a change in our customer base. And so I'd say that's how I would describe it. We see still positive trends in our ad stop metrics, but that's pretty consistent as it has been for the last six to twelve months.

Andrew Steinerman, Analyst

Okay, thank you very much.

Todd Schneider, President and CEO

Yes sir, thank you.

Operator, Operator

And our next question comes from Jasper Bibb from Truist Securities. Please go ahead, Jasper.

Jasper Bibb, Analyst

Hey, good morning guys. You mentioned year-on-year tailwind from energy. But was just hoping to get some additional color on other cost inputs, I guess specifically, labor and materials.

Todd Schneider, President and CEO

Good morning, Jasper. We are seeing inflation decrease, although not as quickly as we would prefer. Cotton prices have stabilized, and freight costs are also coming down, which is significant for us. The labor market is becoming less tight; while it is still challenging, it is improving. As the labor market continues to ease, we expect a reduction in the pressures on wage growth.

Jasper Bibb, Analyst

Thanks. And then I wanted to follow up on first aid. Operating margins there were really strong in the first half. Should we think about these like low 20% levels as sustainable going forward? And would you say there's anything that's changed there that's unlocked another leg of operating margin expansion here today?

Mike Hansen, Executive Vice President and CFO

Sure. Jasper, we have seen some nice performance in that business and I spoke to a few of them where from a margin perspective, first of all, the value that we sell with, nothing is more important than the health and safety of your employees is really still resonating well. And so our growth has been really good in that business. We talked a little bit in the opening comments about sort of the recurring revenue streams of AED rentals, our eyewash stations and our WaterBreak. And these have been great businesses for us. The growth has been really good and the margins are great for us. Many times these are add-on products to existing customers. But in all three of them, we install, and then we have a recurring service program that goes on after that. And again, it leads to really nice stickiness and also nice margins. The other thing that I'll point out is we opened a first aid and safety distribution center a couple years ago and that allows us to source more. It allows us to centralize some of our sourcing, and those kind of things lead to a better product cost, and that again drives down the material cost in our first aid and safety business. So the combination of really good sales mix, really good growth in the business, good sourcing, the one I didn't mention was SmartTruck technology that is also having a benefit there. All of those things are contributing. And so this is not a case of six months of sort of unusual items. This is a little bit of a lot of hard work and execution by our first aid and safety partners to really get this margin going.

Jasper Bibb, Analyst

Very helpful. Thanks for taking the questions.

Operator, Operator

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

Faiza Alwy, Analyst

Yes, hi, thank you, Todd. So I wanted to follow up on both the first aid business and the fire business. You touched on the first aid a little bit, but curious on what's driving the acceleration, if you could expand on that, both on first aid and fire. And then as we think about your outlook, do you expect this level of growth to sustain looking ahead? And, I know in fire, you talked about an SAP implementation that was happening in this fiscal year. So maybe is that helping the top line? Has that happened? How should we think about margins going forward in that business?

Todd Schneider, President and CEO

Good morning, Faiza. Thank you for the question. We have a strong interest in the fire business. It is the only sector where having it is legally required, which creates a unique market where everyone is a programmer. However, we are effectively cross-selling within this market. Utilizing various technologies, including SmartTruck, enhances our partners' success across all our business lines. We are experiencing growth that we find attractive, though managing a business has its ups and downs. Nevertheless, we are optimistic about the long-term prospects for the fire business. As you mentioned, we are currently in the process of implementing SAP, and while we have not yet seen any benefits since it hasn't been implemented, we are hopeful that it will positively impact our business in the coming years.

Mike Hansen, Executive Vice President and CFO

I'll add a couple of points. The market opportunity in those sectors is quite large, and we expect that they will continue to grow at a rate close to double digits in the near future. Additionally, we haven't started the SAP implementation yet. As we prepare for it, which will likely occur in the next fiscal year, we might experience some pressure in the fire segment. Since benefits from an SAP conversion don't materialize immediately, we will incur extra costs in 2025, but this will set us up for significant benefits down the line for that business.

Faiza Alwy, Analyst

Great, thank you. And then if I could just follow up on the macro environment, you made some comments in response to a previous question around just you’re being prudent and there is some uncertainty. Just given sort of how well you are doing with no programmers and the momentum you are seeing in sort of these other businesses, I'm curious if you can give us a framework in terms of how we should think about the impact of macro on your business.

Todd Schneider, President and CEO

Well, I'll start, Faiza, with, our history has been we grow certainly in multiples of GDP and employment growth and you hit it. We are able to sell into no programmers. Even when they're not, let's say, adding people, we can take pressure off of them by managing programs for them. So our new business effort is always really good. But certainly, if we see turns in the economy, we've got to adjust potentially. If we see our customers start to reduce their number of people, we've got to adjust. And so it is prudent for us to sort of think about that as we look into our guidance and into the future of the business.

Faiza Alwy, Analyst

Understood, thank you so much.

Operator, Operator

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

Seth Weber, Analyst

Hey, good morning and happy holidays, guys. I wanted to just go back to the clean room discussion for a minute. If there's any way to frame how we should be thinking about that, new facility openings, and are those facilities higher CapEx relative to a traditional facility? Is there any way to combine facilities or I'm just trying to get a better understanding of this opportunity and what the investment might be for Cintas going forward? Thanks.

Todd Schneider, President and CEO

Thank you for the question, Seth. As you know, that’s a segment of the uniform market. It seems that more companies have higher cleaning quality requirements in the last decade, so we see this as a positive trend. In terms of the capital expenditure needed for a facility like that, it’s quite similar to a uniform facility. The main difference is that it typically serves a larger geographic area than a traditional facility. This is necessary because we have limited facilities that need to cover a broader customer base, resulting in a larger geographic area being served by each of those facilities.

Seth Weber, Analyst

Is there any way to estimate how many of these facilities you might be opening over the next couple of years? I saw the press release for the Wisconsin facility, but will it be just one or two, or could the scale be much larger in the future?

Todd Schneider, President and CEO

Yeah, Seth, you shouldn't expect to see just a few openings each quarter or year given the market size. The pace will depend on demand from the marketplace. If more customers show interest, we'll be ready to meet that demand.

Seth Weber, Analyst

Okay, that's helpful, thanks. And then maybe just a quick follow up on the direct, it's nice to see the direct sales business turn positive again in the quarter. Is there any color on whether that's coming more from the service side of your customer base, more of the manufacturing side, and any just detail there or is it just kind of across the board?

Todd Schneider, President and CEO

Good question, Seth. The design collective business's direct sales segment is quite unpredictable. The growth is mainly coming from national accounts, particularly in hospitality and lodging. When they implement new programs or rollouts, we experience spikes in sales. While we appreciate these spikes, the activity that follows is typically not as strong, so I wouldn’t view it as a major growth driver for us.

Mike Hansen, Executive Vice President and CFO

Yeah, we typically would say in the low to mid-single-digit growth. So this quarter is sort of in line with that expectation.

Operator, Operator

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

Stephanie Moore, Analyst

Hi, good morning. Thank you. I wanted to discuss the potential for cross-selling over time. You've been performing exceptionally well with your investments, especially in technology, and you've mentioned improved visibility. Could you share how these investments might influence cross-selling? Specifically, I'm curious about the opportunity to introduce additional products and deepen our engagement with existing customers. How are you managing the incremental products that you can offer over time? Thanks.

Todd Schneider, President and CEO

Good morning, Stephanie. You can think about it as cross-selling, which occurs between different divisions. There's also upselling, where we have products that our customers may not be utilizing fully, even within specific divisions like rental or first aid. All these factors contribute to our growth, and we see significant potential in these areas. We're working to ensure our employees have the right information and positioning to assist customers effectively. Additionally, part of our corporate culture involves ongoing investment in new products and services. We continuously gather ideas from our customers, test them, and subsequently launch them. This approach has always been a vital aspect of our growth and continues to be. Thank you.

Operator, Operator

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

Scott Schneeberger, Analyst

Thanks. Good morning, everyone. Happy holidays. I want to start by discussing the SG&A growth in the low double digits, similar to what you experienced last year. You mentioned investments in selling resources, a management training program, technology, and talent acquisition efforts. I'm interested in hearing more about the labor situation, which you've indicated is improving but still challenging. Can you provide more details on how you're approaching selling in this context? Additionally, could you expand on the technology aspect? If you've already addressed it in this call, I understand, but I would appreciate any further insights. Thank you.

Todd Schneider, President and CEO

Good morning, Scott. The items you mentioned are very important to us. I wouldn't single out any one in particular, but I believe the future looks promising, and we want to invest in it. We understand the necessity of our talent acquisition team in attracting top talent. Our management trainee programs are essential for developing future leaders, and we consider them a vital pipeline for leadership. Additionally, the resources for selling are promising, especially considering our customer base and the size of the market. With around 1 million customers and approximately 16 million businesses, the opportunities are significant. Technology also plays a crucial role in our strategy; we aim to simplify business interactions with us and harness technology to enhance our partners' success. We want to guide them effectively, provide the right tools, and ensure that it becomes easier for customers to make purchases and engage with us overall.

Mike Hansen, Executive Vice President and CFO

Sure, not a lot of change in the strategy, Scott, and that is we love rental tuck-in opportunities and we've made a number of those this year. And as you can imagine, when we do that in a marketplace, we add immediate capacity utilization improvement, route density, and so those things really help us in the rental business. So we've made some of those. We certainly have made some first aid acquisitions, and we've made fire acquisitions. Again, the dynamic is similar in all three of these. These are really nice tuck-in opportunities that just strengthen our business in the local markets in which we acquire them, and we'll continue to look for those opportunities as best we can.

Todd Schneider, President and CEO

One thing I might add is, to Mike's point, we get synergies. It helps us with density, helps us with capacity utilization, allows us to spend more time with the customers. So all that's valuable, but in each of the businesses, depending upon the business we acquire. But normally when we make an acquisition in rental, first aid, or fire, we're able to provide an offering to that customer base that's broader than what they had in the past. So the rental waiver broader offering than most companies out there, certainly in the first aid we do as well. And depending upon the fire acquisition, that's very consistent. Separate from, then we can cross sell. So it adds nice value.

Operator, Operator

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

Shlomo Rosenbaum, Analyst

Sorry, my line was muted. This is a question basically for Mike, just a little bit going through some of the technical items in the quarter. Receivables days were up two days sequentially. I was wondering if there was a lot of business that came in at the end of the quarter. Are you seeing any changing patterns in what clients are paying or any other factors in that because the last time we saw 48 days was during COVID.

Mike Hansen, Executive Vice President and CFO

Shlomo, when our quarters end on a holiday and it seems like too many of them do, it does create a little bit of disruption in terms of the ability to collect the mail, the application. We have seen maybe just a touch of slowing in the AR, but we've not seen any, I'll say deterioration from the standpoint of additional write-offs. But we did see a little bit of slowing, and the Thanksgiving holiday can usually contribute to that.

Shlomo Rosenbaum, Analyst

Okay. Then in the OPM, the operating margin, the other unit was up very nicely sequentially, even though there's one less day sequentially in the quarter. Could you just give us some of the mechanics or tell us just what's going on on the ground over there? It's increasing the margin very nicely and is that something that we should expect to continue at kind of that 16% level?

Mike Hansen, Executive Vice President and CFO

The revenue growth is strong across all our businesses, and it's significant when we experience notable revenue increases. Additionally, the uniform direct sale business improved from a negative 2.7% in revenue growth to 4.7%, which is also important for operating margins. We observed considerable improvement in direct sales, and while nothing stands out too much, we did see a nice acceleration in revenue.

Operator, Operator

And our next question comes from Leo Carrington from Citigroup. Please go ahead, Leo.

Leo Carrington, Analyst

Thank you, and good morning. If I could ask a follow up on that point around the one-off or the cost that you called out in Q2 around current acquisition, training, technology. Were you calling them out to any of these one-off increases in nature or more to highlight where the spend is? And then in terms of the underlying margins and drop through in Q2 on your organic growth, do you see that as sustainable when you factor in the additional investment this quarter?

Mike Hansen, Executive Vice President and CFO

Well, Leo, I want to emphasize that we're focused on the long term and committed to investing in the business. These investments are crucial as they create more opportunities for penetration, cross-selling, productivity improvements, and capacity utilization. We highlight these efforts to demonstrate our dedication to long-term growth and our intention to continue investing. As Todd mentioned multiple times, the future looks promising, and we aim to capitalize on that by reinvesting in the business. In this quarter, we achieved incremental margins of 27%, and we expect to maintain margins in the 20% to 30% range moving forward. We acknowledge that while we're currently at 21%, we need to aim for the upper tier of that range, and we believe we can accomplish that. Our investments in SAP, technology, and other areas are yielding this 27% margin, even as we make those investments. It's essential for us to communicate these future margin and revenue opportunities.

Leo Carrington, Analyst

Very clear. Thank you.

Operator, Operator

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

Toni Kaplan, Analyst

Thanks very much. You mentioned the success that you've had with the branded products earlier, particularly with Carhartt and Chef Works. Could you just remind us if these are exclusive relationships and how long the relationships are for and then are there any other areas that could benefit from branded products or equipment that you could offer as well?

Todd Schneider, President and CEO

Good morning, Toni, thank you for the question. We have a longstanding relationship with Carhartt and Chef Works, and we are the exclusive licensees for their rental programs. We collaborate with them to design products that users enjoy wearing and that also integrate well with our processing systems. This is very important to us. While we don't disclose specific contractual arrangements, we do appreciate products that excite our end users. Carhartt and Chef Works are excellent examples of that, as they are strong companies with great brands and products. We are continually seeking other opportunities and spend a lot of time with our customers and partners to explore where those may arise. These two relationships are significant and longstanding for us.

Toni Kaplan, Analyst

Yep, terrific. And maybe if you could just give us your latest thoughts on potential international expansion, that'd be great. Thanks.

Todd Schneider, President and CEO

I would say, similar to products, we're always exploring those types of opportunities. We certainly maintain communication with the individuals managing those businesses. The good news is that we don't need to do that to be very successful in the future. We're currently serving about 1 million businesses, while there are 16 million businesses in the US and Canada. The exciting part is that by the time we reach 2 million customers, there will be more than 16 million businesses in the US and Canada. This may seem discouraging if you're in a competition, but it's actually thrilling if you're in business because once we hit the 2 million mark, the competition will expand. We will also introduce more products and services in the coming year. So overall, we keep monitoring, evaluating, and looking for the right opportunity, and if that opportunity arises, we will take action, but it’s certainly not necessary for our future success.

Operator, Operator

And at this time, there are no further questions. I'd like to turn the call back over to Jared Mattingley to close out the call.

Jared Mattingley, Vice President, Treasurer and Investor Relations

Thank you for joining us this morning. We will issue our third quarter of fiscal 2024 financial results in March. We look forward to speaking with you again at that time.

Operator, Operator

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