Cintas Corporation

Good day, everyone, and welcome to the CENTOS 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.

Thank you, and thank you, everyone, for joining us. With me today is Scott Farmer, CENTOS Chairman of the Board and Chief Executive Officer of 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.

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 enables 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 CentOS culture. They're always striving to exceed the expectations of our customers to maximize the long-term value of CentOS for its shareholders, employee partners, and other stakeholders. The result is consistently strong financial performance with CentOS growing revenue and EPS 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?

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. 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 selling and administrative expenses and impacted operating margin by 100 basis points. The pre-tax gain and related tax benefit impacted EPS by 25 cents. Our balance sheet and cash flow remain strong. Our leverage calculation for our credit facility definition was 1.6 times 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 contains 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.

Thank you, Mike. As Scott stated, COVID-19 remains a significant disruption to the economy. Every business in the US 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 of the virus's 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 have provided some examples of their interactions with both new and existing customers so you have 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. Through 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 health care, education, and government is six times 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 have provided businesses with over 350,000 hand sanitizer dispensers and over 125 million masks. I am 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, healthcare scrubs, mats, and towels, and 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 We're more than offset by higher costs 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 sale 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 multi-million 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. 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.

Thanks. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll take our first question from Andrew Steinerman with JP Morgan.

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.

Andrew, this is Scott. Yeah, we can give you a little bit more color on that. Through the quarter, we continue to see an improving revenue trend. For the month of November, in the uniform rental and facility services segment, rental organic growth was minus 1%. First aid and safety for the month of November, organic growth was 14%. And fire continued to improve through the quarter and it ended November with the month of November down 1%. Now, it's important to note that about mid-November, we did see the impact of some of the state's restrictions on businesses. I would say it affected the trend, but it hadn't turned it around. worse than it had been at that point. So it's a little unpredictable on where it goes. But as you can see, through the month of November, we continued on a positive trend. I think second quarter revenue sequentially grew about 2.7% over first quarter. And could you make a comment about December? I would say probably. Through the first couple of weeks, we were running around where we were in November. Great. Okay. Thanks, Scott.

Yep.

We'll take our next question from Seth Weber with RBC Capital.

Hey, guys. Good morning. I had a couple questions on the margins. I think – You know, I'm just trying to handicap, you know, where we're at with expenses coming back online. I think, Mike, I think last quarter you talked about there was about 100 BIPs, 100 basis points of lower discretionary. Have any of those costs started to come back here in the second quarter? And how should we think about that, you know, kind of through the rest of the year? Thanks.

Yeah, we continue to manage those costs pretty tightly given the environment that we're in. The difference between last year's travel and meetings, which I called out as 100 basis points in Q1, was about 40 basis points in Q2. Now, Q1, we normally travel more as we start our fiscal year, but it was still about a 40 basis point benefit. And, you know, we'll continue to monitor the situation. Certainly, I know that our operational people are itching to get out and see our locations and our customers, but, you know, given the levels of COVID cases and the environment, we're going to remain pretty tight on those.

Okay, can you just talk about, have you seen any relief on the cost side on the first aid and safety category? I know there have been some cost pressures there. Has that kind of loosened up here a little bit with more, whether supply has gotten a little looser or just easier to get? Any comments on the first aid safety expense cost side?

Seth, this is Todd. Regarding the first aid business, Certainly, there are some PPE-type items that are still very challenging to get. We've been blessed to be in a good inventory position to help our customers out with those items. But PPE is in short supply. It's had some impact on costs to us in those cases. But again, we've looked at it with a long lens and We've invested appropriately, and our customers really appreciate the fact that we've been able to provide products and services such as PPE and other items to help them get through this challenging time.

We do like, Seth, the sequential improvement of gross margin of just about 40% in Q1 to 43% in Q2, and so we did see some nice performance in our first aid cabinets in the quarter. And as we talked about in September, that mix of PPE obviously came down a bit with the growth moving in that segment from over 20% Q4 to 17% to 14.5% here in Q2. So we're starting to see Some of those PPEs turn into the maintenance mode that we've talked about in the last couple quarters, and that mixed change as well as the improving first aid cabinet has helped that gross margin. When we get to a more normalized environment, we certainly believe that those first aid gross margins are going to trend back towards where we had been pre-COVID. There's nothing structural or no change in the business that would lead us to believe otherwise.

We'll take our next question from George Tong with Goldman Sachs.

Hi, thanks. Good morning. You mentioned that through 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?

Yeah. Our new business numbers continue to perform very well. We still believe that the value proposition that we have is important in this current environment, and so we continue to attract new customers. We haven't seen a change in lost business rates at this point. We have seen, because of government restrictions, some customers going back on hold, meaning they're temporarily closing the business until the restrictions are lifted. And that would be the change that we've seen since about mid-November in the economy. Those restrictions are various states and cities. It's California, it's Illinois, it's New York, other states, Washington, Oregon, even up in Toronto. So these are the places that we see those type of restrictions that are impacting our customers. But from a lost business standpoint, we haven't seen a real change in lost business rates.

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 healthcare as a vertical is contributing to growth currently?

Sure. The no-programmer market for us, we've tracked it for many years. It's between 60% and 65% of our new business customers it remains in that range today. And as I said in my opening remarks, there are millions of businesses out there that do not have a program that we can offer them. And so we like our position and our ability to convert them. Even within the healthcare space, there are If you define a no programmer as somebody who doesn't have a rental program, most of the scrubs that you see in hospitals are direct sale type scrubs, some of them bought by individual healthcare workers, some by the hospital for departments and things like that. But converting them to a rental program, we would call a conversion of a no programmer. The other area that we're seeing in healthcare that's doing really well are isolation gowns. Those are traditionally direct sale disposable gowns, and we have a rentable alternative that actually saves the hospitals and healthcare providers money to convert from a direct sale program to a rental program. So we're seeing a lot of success in that as well, and that would be what we would consider a a no-programmer conversion within healthcare.

George, this is Todd. Just to build off a couple items that Scott mentioned, our no-programmer business as a percent of our total remains quite consistent. What is changing is it's allowing us to get audiences to folks, customers, prospects that we haven't had in the past in many cases because of the access we have to critical products and services that they need to provide to their business and within their business to either their customers or to their employees, both, so that they can have confidence to come to work and for people to come into their business. Scott spoke about some in the medical area have been very successful, the isolation gowns, hand sanitizer, sanitizer wipes, disinfectant wipes. Scrubs, all are in great demand. Scott mentioned that the isolation gowns were, that was virtually, almost the entire market was a direct purchase market, purchase disposal market, probably the best way to describe it. And what we've done with isolation gowns has been very attractive to our prospects and our customers today. You know, it's a green service, right? We're not just throwing it in the trash. We're reusing it. It saves them significant money. The availability of them instead of folks struggling to get isolation gowns and being panicked over trying to take care of their patients. The garments that we're providing are more comfortable than what they've been wearing in the past. And then lastly, we brought some technology to that business so that we can track exactly how many times those garments have been processed so that we can meet the specifications that are detailed out for such a product. So that's been a big win, and a lot of healthcare customers are very, very interested in that. And we mentioned in our previous earnings release that the demand for scrubs has been up very nicely. People are uncomfortable in many cases wearing those home, Washing those at home and whom they come in contact with on the way home makes people a little uncomfortable. So all that has been quite good demand. In those cases, we consider there's no programmers. We might be doing some business with those healthcare organizations, but we're expanding that relationship dramatically.

We'll take our next question from Hanzo Mazzari with Jefferies.

Hi, this is Mario Cordolacci filling in for Hamza. Appreciate your time. Just on touching on the flowing in November and the continuation into December, could you maybe just give us a level deeper in terms of what you're seeing on your end markets? I'd imagine it's probably similar to what we saw earlier in the year, excuse me, with the high-risk industries being hit a little harder. But, I mean, is that more or less what you're seeing? Or could you give us some of the puts and takes on some of your end market exposure.

Yeah, sure. Uh, it, it, it boils down to, uh, you know, certain industry segments or, uh, geographies and the, uh, you know, the, the, the segments that you, uh, can imagine that travel hotels, uh, uh, cruise lines, uh, even, uh, in certain areas, uh, restaurants, movie theaters, that type of thing, are being hit the hardest because of these restrictions and people, I think, naturally fear to go and congregate in a place like a movie theater. The geographies depend on what type of or if there are any restrictions in place. And what we have seen so far is, as we got through the end of November, It's an increase in the number of states and municipalities that have put restrictions in place. We don't know whether that trend is going to continue through the holidays. And just as an example, Governor Newsom in California put the restrictions in place. They're pretty tight, but he says that they will extend to January the 4th. The question that we have there is, will he extend that further? which has been his tendency, or will it actually be January the 4th when he starts to loosen those restrictions? Those states and municipalities are the areas where we've seen the change since about mid-November. My perspective is that we are in a temporary lull. We don't think it's going to be anywhere near what it was in our fourth quarter last year. Quite honestly, at that point, nobody, including governors and people running businesses, had any idea how bad it was going to be, how deep it was going to go, and so forth. But now that we've got eight or nine months' worth of experience in dealing with it, And the fact that we have vaccines beginning to roll out right now, there's light at the end of the tunnel. This is a temporary period of time that we're going to go through. And so, you know, that I hope provides a little color to you. I'm happy to get more specific in any area if you have any questions.

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 looks like there? So I think recently 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? Sure.

Todd, do you want to take this one, and I'll chime in? Sure.

Okay, great. Mario, I would say in the health care market, it depends upon what area within the health care area, acute, non-acute, even, frankly, into what department you're speaking of. But generally speaking, ISO gowns, scrubs, et cetera, those are a direct purchase market. In the case of ISO gowns, disposable items. would be the most common way people procure those products. Lending companies certainly are in that space, those who provide services to those types of customers. But if I generally had to describe it, it's a direct purchase or disposable market with any reusables would be traditionally with a lending type of companies would be the most common experience. As far as the scrub dispensing, it's been going extremely well for our business and our customers. The demand is there because it's a, well, I think most people can see the experience where you go into a grocery store and you see people wearing scrubs, right? And those belong to the hospital normally. And what happens is because folks struggle to get access to scrubs, they tend to hoard them. And as they hoard them, then they have to buy more scrubs. And when they do that, and they're in that type of situation, they tend to buy the cheapest scrub they can because they end up disappearing. And we completely change the value proposition there. We provide a scrub that people want to wear, not just have to wear. It's comfortable, attractive, and we're continuing to invest in that area and come out with... better technology around the fabrics, et cetera, and makes it completely accessible, meaning there's complete accountability. So when you want a scrub, you can get it. You have complete access, and then it's laundered for you, so they don't have to take it home. So it has been really attractive for our healthcare customers, and as I mentioned in the opening remarks, we've installed twice the amount of scrubs that we did last year at the same time so far through Q2. So great momentum, and we're very encouraged.

Todd, let me add just – this is Scott. Let me add one thing relative to competition. And, you know, Todd mentioned that it is traditionally a direct sale item, scrubs and isolation gowns and that sort of thing. And so I think the thing that's helpful to you all to understand is that it is really difficult, and I don't know that it's even a concept that a traditional direct sale competitor would even consider, would be to try and develop a laundry service to do that. So we're providing a unique opportunity for a customer to convert to a rental program where the traditional competition can't. they don't have the ability to do that. And that is a big significant competitive advantage for us versus the traditional supplier. That and we believe that because of the technology we brought, the scrub machines, the dispensing units, the inventory tracking, and our ability to control how often an isolation gown is processed before we pull it out of service. These are the kind of things that for traditional competition, they can't do. Relative to other rental companies, that would be linen companies and uniform rental companies, we've been in this for a long time. We have trained salespeople and service providers that specialize in the healthcare market, and we think we have a multi-year head start on on what you would probably consider to be our traditional rental competitor. And we like that position a lot, and I think that's why you're seeing the amount of success for us as we've gone through this process and through the pandemic that you're seeing. So I just thought I'd offer that as some color relative to health care as well.

We'll take our next question from Manav Patnaik with Barclays.

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 healthcare. Like, have you seen any changing dynamics if people are getting price aggressive or, you know, there's some more consolidation going on? Just curious, any color there.

Yeah, we'll talk competitive, maybe competitive behavior and pricing. We have seen some aggressive pricing in the marketplace. I think that as competition sees their business, existing customer base have issues and decline in revenue, they typically get aggressive with pricing. I don't think this is anything... that we haven't seen in the past relative to low ball prices and competition trying to take business from us. That's a market by market type of an environment and it could be in any particular market. The small players or one of the big national players in that market that decide they need to do something to try to win some accounts. Relative to overall pricing, though, while we have had to adjust prices on fluctuating items like gloves and face masks and hand sanitizer and the PPE kind of things, as our costs increase trying to get those products, we have had to adjust prices upward on those items. For our recurring revenue across all of our businesses, really, We have not increased prices during the pandemic. And in fact, as a general statement, particularly in the rental division, we haven't increased our prices to our customers in about a year and a half. And that's a strategic decision on our part. We don't think that during a global pandemic, it's the right time to be raising prices. And I think that's... one element of why we've seen our net promoter scores, how we measure customer satisfaction, be impacted to the positive. And so that's our position on pricing at this point.

Scott, if I may, just a couple items on that regarding our approach with our customers. Scott mentioned recurring revenue pricing hasn't gone up in 18 months or plus. And our approach to our customers was to be, we call it, caring, consistent, and flexible, meaning we know it's a very challenging time for our customer base and our prospect base, so we wanted to... take the appropriate approach. Scott mentioned that it's showing up in our customer satisfaction scores, which we track via net promoter scores. And we look at it as what's the lifetime value of those customers. And we want to have those customers for a lifetime and not take a short-term approach. And I think, again, that's showing up in our net promoter scores, and I think it's going to show up long-term in how customers look at us.

Got it. That's helpful. And also, you know, I think you've given examples on how basically your skill plays totally to your advantage in these times where there's kind of heightened demand. Have you seen, you know, maybe some of your smaller competitors just, you know, be financially constrained? And does that present even more opportunities now?

Well, yeah. You know, we... I always like to say we're an equal opportunity competitor. If any of our competition in a particular market is having a hard time with either getting supplies, getting the product that they need, having trouble with servicing their customers, we're more than happy to step in and provide those products and services to those customers. you know, from time to time we do see, you know, an issue with a competitor and, you know, we will react accordingly on a customer by customer, prospect by prospect basis, if you will, relative to that. I don't know that it's because of the, you know, it's still a little uncertain in where this is all going to go and how quickly it's going to end. It different opinions on that, but I do think that it could provide a future opportunity for acquisitions. I think that there would probably be a desire on the part of a potential seller to try to get their revenue back to where it was pre-COVID to have something larger to sell, but that will deal with those kind of situations as they come up, but that is obviously an opportunity for us as well.

We'll take our next question from Andrew Whitman with Baird.

Great. Thanks for taking my questions, guys. I think this one's probably for Mike. And just kind of looking back here on calendar 2020, it's obviously been a remarkable year, challenging year for so many people. I mean, the thing that I think most investors will look back and think about Cintas is how you managed through this and seeing your margin percentage go up despite the revenues declining. And so, Mike, I guess the question is we look ahead from really just high levels I'm looking for here. As we're almost about to annualize the COVID comps, if you will, how should we be thinking about the margins? I mean, you guys have articulated the travel and discretionary 100 basis points last quarter, 40 this quarter of benefits. But are there other buckets out there that could be margin headwinds as you hit the year and annualize the COVID things? I don't know, things like incentive compensation, fuel prices, other things that might have to come back in on the production side of things. What else should we be thinking about from a high level as investors that could come back in as we hit the year mark on COVID?

Yeah, it's been a challenging year, and it has required a lot of different managing of the different cost structures, and it certainly has been a challenge. But as we move forward, look, there are certainly some things that we have learned about some of our costs like travel and And can we do some things more efficiently? And I think there will be permanent savings on some of those things. There will be some of that that comes back, but I don't think we're going to see 100 basis points of movement in something like that. And so as we look forward, Andrew, I would say this. We want to grow over the course of the long term. We will continue to staff revenue-producing positions to prepare ourselves to grow. And that may mean a little bit more bench in our service departments and in our sales departments. And that will probably create a little bit of additional spending. But having said that, Scott's managed the business very, very well in this period of time, and I would expect that that is going to continue. We will continue to be very, very cognizant of our margins and our costs and recognizing that our goal is to continue to see very healthy incremental margins. So, Andrew, there's not really anything that I would point to other than a little bit of that travel coming back, and a little bit more of the staffing of revenue-producing positions that are needed for growth.

Okay, great. That's my only question for today. Have a good holiday season, guys. Thank you. You too.

We'll take our next question from Tim Mulroney with William Blair.

Yeah, good morning. Just one for me as well on employee retention, which I know is a key initiative for the firm and something you all track pretty closely. I'm curious how that's trended through the pandemic. You know, 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 if 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.

Tim, this is Todd. Thanks for the question. Employee, what we call partner retention, is never easy. But I will say that our performance since the start of the pandemic has been impressive. The results are continuing to improve. We have – our partner base is an impressive group of folks who are relentless, creative, and very proud of what they're doing on a daily basis to help businesses function in this environment and function successfully. So there's some esprit de corps in the organization that they're very proud of what they do. And we've got a great group of leaders and frontline partners all throughout that we're very happy with. And so, yeah, it's going quite well, and we're really encouraged about that as we move through. When you go through really hard things, right, and going through this pandemic has been extremely challenging, not just for ourselves, but for I'd say, well, you can say the world, right? It's been very challenging. But it makes you better, makes you stronger, and we have found out a lot about our partners and how resilient they are, and it's been a real pleasure.

That's great. Great color, Todd. Thank you. Thank you, Tim.

We'll take our next question from Gary Bisbee with B of A Securities.

Hey, good morning. First of all, I just wanted to clarify one thing. Todd, you said health care, education, government, customers. I believe you said new businesses doubled year over year, but then you said something else is up six X. What were those two numbers?

Yeah.

I want to make sure I got that right.

Gary, happy to clarify. So I was speaking of two different sectors, one for rental and facility services business, those sectors, the healthcare, education, and government, new business is up double in that area. And in the case of first aid, fire, and other, our new business, again, for healthcare, education, and government is up 6x. Now, as I mentioned in the opening remarks, not all of that will be repeating. Some will not, but nevertheless, we're really, really encouraged by how well we're doing in those areas of our business.

And can you give us some color on the rest of the end markets you serve? I mean, obviously, those you've been calling out, and it makes sense that you're doing really well. But, you know, is the rest of the book down on a new business? Or how do we think about, you know, sort of total centos at this point, including the good and the bad?

Yeah, 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 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 expect in a more normalized type economy.

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 bring 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 cash flow? Thank you.

Well, let's start with CapEx. You know, I think that we're going to probably see CapEx remain below historical levels until we get through the COVID crisis and the economy recovers. But I'd still say that even today we're probably spending CapEx at a 60% growth, 40% maintenance level. but I just think it's going to be lower until we get through this. Everybody's a little more cautious and that sort of thing. Relative to inventory, it's important that I think we make the statement that we are doing the best job that we can to manage the supply chain and the supply of these hard-to-get items with the demand that we're seeing from our customer base, and that's the primary reason you're seeing an increase in this inventory. I don't believe that we're going to see a sudden drop-off in the need for these products. I think it will be a slow increase. a steady decline, and we'll have some view on that as the economy recovers and as COVID vaccines continue to roll out. Many of these are going to be around at a higher level than pre-COVID for a long, long time. And so we haven't seen any issues with slow-moving inventory at this point. or anything like that. But I will tell you that the fact that we have been able to bring these products into inventory the way that we have has been a huge competitive advantage for us in the marketplace where because we might have masks or gloves or hand sanitizer, prospects who ordinarily have not been doing business with us listen to and react to our ability to provide them with these COVID-related products and then also listen to what else we can do for them. And so it might be a call where a company is interested in hand sanitizer and we wind up after our sales rep is out talking to them where they're putting 10 people in uniform and restroom supplies in the restroom and entrance mats and mops and cleaning chemicals and so forth in addition to the hand sanitizer. So it's been a big competitive advantage for us as we've gone through this process And I think one of the reasons why our NPS customer satisfaction scores are up, as well as we're seeing very robust new business results. So, you know, I think the balance sheet that we have has allowed us to be able to make that investment. Our supply chain has done a great job in sourcing it, and I think that it's reflected in our ability to sell new accounts and satisfy our customers.

We'll take our next question from Kevin McVey with Credit Suisse.

Great, thanks so much. Hey, I wonder if you could give us a sense of, across a 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 the potential to scale as things start to reaccelerate from a COVID perspective? Or recovery, rather.

You know, that's difficult for us to say because in many ways it's a moving target. We have had customers that were open and then because of a regulation or a restriction had to shut down temporarily, open back up. Some of the customers that are open are open only at, you know, 50% capacity or at a lower level than they were. But we haven't gotten into those figures because it moves around so much that if I tell you something today, it could be different next week. And so we, you know, depending on who might apply new restrictions and so forth. So we haven't gotten into that level of detail, and I hesitate to do that only because I think it might be a little misleading only because it moves around so much.

Good. Okay, thank you. And then just, you know, in the kind of post-COVID world, you know, if you think about how much of the demand is structural, is there any way to think about that against the core business in terms of it seems like obviously healthcare 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, you know, maybe starts to kind of normalize?

We've learned a lot as we've gone through this process, and I think that one of the really positive aspects of this whole thing is that we have done a much better job of communicating to existing customers and even prospects all of the things that we can do for them, and therefore are selling more to existing customers and a new prospect that might come on board. They may only start with a particular service, but because they're aware of the other things that we have to offer, when they see that need, they know who to call. That has been a structural change for us, and I believe that the things that we have to offer these customers are things that they're going to be using in the long term within their businesses to help keep their businesses, their employees, and their customers safe have a clean environment for them to work in, be compliant with regulations and the fire business insurance company requirements and so forth. So we're excited about the position that we're in right now. And as I look to the future, I'm really excited about where all this can go.

Kevin, this is Todd. As an example of that, we mentioned in a previous call that There's a large national bank chain that we were doing zero business with, and now we're providing hand sanitizer to every single branch that they have. In addition to that, we're talking to them about other facilities products that they are in need of. We're also talking to them about our fire service, which, as you can imagine, they need all of that. It's just a matter of where they're getting it from and centralizing spend, in many cases saving money, So that's just one example of what is occurring hundreds of times every single day out there with our sales and service organization. As Scott mentioned, it really positions us well because there's people in the past who really wouldn't take our calls, and now they will because of our inventory position and our infrastructure. And that helps position us for the long term in a really healthy manner.

It makes a ton of sense. I've noticed a lot of dispensers being kind of installed and things like that that just historically weren't there and, you know, that bodes well for the future. So thank you.

Thank you.

We'll take our next question from Scott Steinberger with Oppenheimer.

Thanks very much. Good morning. In the other segment, I'm just curious, how is your visibility there? You're obviously experiencing some new wind. and seen some struggles, but if you could break it down between FHIR and direct sales, just a sense of the visibility you have, and this is the essence of the question is, you've done a nice job managing margin there. How does the visibility correspond with your ability to manage your op-ed perspective?

Well, the fire service business is recovering similar to the rental and facility services segment. I mentioned earlier that their November organic growth rate was off 1% from pre-COVID levels. So we have a pretty good view of what's happening in that business, and I think that will – similar to what happens with the rest of the economy and what happens with the rental division, we'll see that recover in a similar fashion. Relative to the direct sale business, a good portion of that business goes into hospitality and travel-related areas. That's a little murkier, and I think that those are hotels, airlines, cruise ships, casinos, and food service and that sort of segment. So those are going to be, I think, the longer tail from a recovery standpoint. But I think that there will be a day coming where they're going to get a pretty good bump. I think there is, in my personal opinion, a huge amount of pent-up demand for people to be able to go back on vacation and to stay in a hotel to feel safe when they get on an airplane and that sort of thing. And there's a point at which when the vaccines have been rolled out to perhaps reach herd immunity, you can see airlines throwing some special rates at travelers to welcome them back, hotels and resorts doing the same kind of thing. I think you'd see Las Vegas doing everything that they can to get their customers to come back. And who knows, maybe that's early next summer, depending on the rate of vaccinations and things like that. But if it's going to work in those businesses, it's also going to work in other businesses. People are going to be able to go back out to their restaurants and their movie theaters locally and Maybe go to the concert venue and do the social things that bars and do the social things that they're missing right now. And I think that that is coming. When it happens, we need a little bit more time to understand the rate of rollout for the vaccines. And that's why I continue to say that we're in a temporary lull in this. and that, you know, as we get a little further out and get a little more clarity, we're going to see, I think, some economic activity pick up, and we're maybe a couple of quarters away from that, maybe on an improving quarter-by-quarter basis as those vaccines roll out.

Thanks, Scott. Appreciate that, caller. And just as a follow-up, I'm curious on COVID. your appetite for M&A and what you're seeing out there as you're clearly in a position of power, which is kind of discussed over the course of the call, and then maybe two cents on the move to the quarterly dividend and just back on the whole return of capital strategy.

Yeah. So relative to the dividend, you know, we were – sort of the last person standing relative to giving out annual dividends. We thought and have talked about it at a board level for a long time and made a decision to make the change. I think it's, you know, we have shareholders that we've heard from in the past about, you know, cash flow and that sort of thing. So we We've reacted to that. We think it's a good change for us. We think it's a good change for the shareholders as well. And remind me, the first part of the question was?

M&A, Scott.

Oh, M&A, M&A. Okay, thank you, Mike. I'm sorry. You probably dropped off, but M&A, yeah. You know, we're cautious right now because of where we are in the recovery phase. but we are in a position where we could do M&A acquisitions in any of our businesses. We'd evaluate them pretty heavily right now just to make sure we understand how well that particular business is doing, but we would be acquisitive if we could find the right deal, the right business at the right price. I think that, as I said earlier, I think there is an element of concern on the seller's part. If their revenue is below where it was pre-COVID, that they're going to get out of the business what they need to get out of the business should they sell it. And so there may be a little bit of a lull there. But I think as the economy continues to pick up, we'll probably see M&A activity increase. pick up, and if that's the case, we sure would like to be a player there.

We'll take our next question from Tony Kaplan with Morgan Stanley.

Thank you. I was hoping you could provide some clarification on the operating assets that were sold during the corridor. I just wanted 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?

Yeah, sure. You know, it was really just a couple of key focuses. We had some operations in some pretty remote geographies that those particular geographies didn't lend themselves to have an opportunity for a lot of growth. And so we had a lot of resources dedicated to running those operations, and they just weren't important geographies for us. We also had some services that we had been experimenting with, if you will, that We came to the conclusion that we had better opportunities to grow other segments of the business, so these are the areas that we sold. It wasn't really material. Total revenue run rate was about $15 million annually, so I don't think that it's going to have any short-term, mid-term, long-term impact on our run rate.

That's helpful. 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, you know, 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, you know, better than 4Q on the downside, but, you know, 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.

Yeah, let me try to explain it this way. You know, we're in a... I think that it's the timing of our quarter and therefore this call that are causing part of the problem. There's so much uncertainty right now as we look out over the next several weeks, a couple of months, a few months maybe, and it's everything from the rising counts of the virus. We have governments putting more restrictions in place. As of today, I don't know whether more governors and mayors are going to do that, whether they're not going to do that, how long those restrictions are going to stay in place based on the ones that have put these things in place so far. We have a typical period between Christmas and New Year's where traditionally we have a group of customers close down their facilities for the holidays anyway. We don't know this year whether that means they're going to extend that. or not, and so that causes a little bit of cloudiness. We've got an election in Georgia coming up in a few weeks that will determine what happens in the Senate. So there's a lot of uncertainty. When we sat down and talked about it, we said, well, let's put a range together. But when we started to put a range together, we started saying, well, what if this happens, and what if that happens? And those would be things like What if a governor or a group of governors decided, well, the vaccine is three months away. Let's leave these restrictions in place for the next three months. What does that do to our ability to predict what our low end of the range might be? What if that doesn't happen? What if Governor Newsom actually does open the California's economy back up January the 4th? So it became such a wide range that we decided it didn't make sense for you. Our impression of, and I hope you take this the right way, but our impression is that one of the things that you like about our company is that we're pretty predictable. And when we give guidance, you can pretty much determine in your models what that means relative to what you think is going to happen. In this particular case, We don't think that what we would provide for you would allow you to do that, that you might wind up with some big swings depending on your positive or negative approach, depending on what you think is going to happen in the economy, and therefore we decided it didn't make sense for us in this period of time to do that. I do not believe, this is my personal opinion, that it will be anything near like what happened in the fourth quarter for us. That was brand new, and I think there were 38 states that put shelter-in-place orders in place in a short period of time. We haven't seen that. I don't expect that that's going to happen at this point moving forward. Might it? Maybe. Maybe. My personal opinion is that won't happen. Therefore, I don't see that as the eventual downside of what's going to happen. The upside could be that the number of cases begin to subside, that mayors and governors begin to open their economies back up in anticipation of vaccinated progress, and so forth. But I do know this, with the vaccines rolling out, I can't predict the rate yet. I need a better understanding of what that is going to be. But with those vaccines rolling out, fewer and fewer governments are going to put restrictive orders in place, and eventually those economies and those states and municipalities are going to begin to recover at a pretty good rate. Is that in our fourth quarter? I'd love to see that. Is it next summer? Highly likely that by next summer, some point next summer, we're going to be at that position. But that's my view of it, and so I'll end with that.

We'll take our next question from Shlomo Rosenbaum with Stifle.

Lomo, you may be on mute.

Sorry, I am on mute. Thank you. Thank you for calling that out. I just have a few. It's been great. Great caller over here. Thank you. And I have a few housekeeping items that I thought we could just kind of run through. Maybe it will be helpful. Just on some of the, can you give a little more detail on kind of the one-time sales, moving to subscription sales? Is there some way you can just get into a little bit more about how that impact might have happened in the quarter and Kind of the success that you're having over there, is this something that, you know, is kind of a little bit more of a permanent lift that's over there? And then I have a couple more after that.

Yeah, Shlomo, this is Todd. You know, we mentioned in our most recent quarterly release that, you know, customers, when they buy large orders of PPE, whether it's a government, a school system, could be healthcare, could be an up-and-down-the-street business, They tend to make a large buy, and then they go into maintenance mode from there. And some of those large buys were in our Q1. There were some in Q2. Some of those that bought in Q1 are now in maintenance mode and were in Q2. So it's a real mix. And trying to predict for those folks how long they're going to need those products and services, the access to them is a dynamic process. marketplace. So again, that's why we're very good, why we've invested for our customers in these inventory levels to help them with that. So hopefully that gives you a little bit more cover.

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 gain pre-tax on 108 million shares to be 25 cents of EPS. Did that trigger some other kind of tax benefit or something with that gain of sale?

It's a great question, Shlomo. It did, yes. The assets had a high tax basis and created while a book gain, a tax loss. And so you can kind of think of it as the $18 million pre-tax gain was about a 12 cent benefit and the tax benefit was about a 13 cent benefit. And maybe said a little bit differently, the 13.3% tax rate was benefited by about 270 basis points. I'm sorry, 370 basis points from these transactions. and the remainder of that tax rate, call it 17% without that benefit, did have some benefit from equity compensation, as we've talked about in the past. As you think about that tax rate moving forward, I would suggest in the third quarter you think about a range of 20% to 21%.

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.

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.

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