Cintas Q1 2023 Earnings Call Transcript

Participants

Corporate Executives

• Paul F. Adler, Vice President-Treasurer & Investor Relations
• Todd M. Schneider, President & Chief Executive Officer
• J. Michael Hansen, Executive Vice President and Chief Financial Officer

Analysts

• Ashish Sabadra, RBC Capital Markets
• George Tong, The Goldman Sachs Group, Inc.
• Andy Wittmann, Robert W. Baird
• Tim Mulrooney, William Blair
• Manav Patnaik, Barclays PLC
• Andrew Steinerman, J.P. Morgan
• Faiza Alwy, Deutsche Bank Aktiengesellschaft
• Heather Balsky, Bank of America Co.
• Seth Weber, Wells Fargo & Company
• Shlomo Rosenbaum, Stifel Nicolaus
• Scott Schneeberger, Oppenheimer Holdings Inc.
• Toni Kaplan, Morgan Stanley

Presentation

[Operator]

Good day, everyone, and welcome to Cintas First Quarter Fiscal Year 2023 Earnings Release Conference Call. Today's call is being recorded.

At this time, I would like to turn the call over to Mr. Paul Adler, Vice President and Treasurer, Investor Relations. Please go ahead, sir. Pardon me, interruption, Mr. Adler, we're unable to hear you.

[Paul F. Adler, Vice President-Treasurer & Investor Relations at Cintas]

Thank you. Yes, we were still on mute. So, thank you for joining us. With me is Todd Schneider, President and Chief Executive Officer; and Mike Hansen, Executive Vice President and Chief Financial Officer. We will discuss our fiscal 2023 first quarter results. After our commentary, we will open the call to questions from analysts.

The Private Securities Litigation Reform Act of 1995 provides a Safe Harbor from civil litigation for forward-looking statements. This conference call contains forward-looking statements that reflect the company's current views as to future events and financial performance. These forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those we may discuss. I refer you to the discussion on these points contained in our most recent filings with the Securities and Exchange Commission.

I'll now turn the call over to Todd.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you, Paul. We are pleased with our start to our fiscal year 2023. First quarter total revenue grew 14.2%. Each of our businesses increased revenue at a double-digit rate. The benefits of our strong revenue growth flow through to our bottom line. Excluding a one-time gain recorded in last year's first quarter selling and administrative expenses, operating income margin increased 20 basis points, and EPS grew 12.3%.

Our sales force continues to add new customers and penetrate and cross-sell our existing customer base. Businesses prioritize all we provide including image, safety, cleanliness and compliance. In challenge with labor scarcity and rising costs, businesses continue to turn to Cintas to help them get ready for the workday. I thank our employees than we call partners for their continued focus on our customers, our shareholders and each other.

Turning now to our business units. Uniform Rental and Facility Services operating segment revenue for the first quarter of fiscal '23 was $1.70 billion compared to $1.51 billion last year. Organic revenue growth was 12.3%. Revenue growth was driven mostly from increased volume. Additionally, price increases contributed at a higher level than historically. We believe such a mix of revenue drivers volume versus price is healthy and supportive of continued long term growth.

Our First Aid and Safety Services operating segment revenue for the first quarter was $234.2 million compared to $199.1 million last year. Organic revenue growth was 15.8%. This rate reflects the continued momentum of our First Aid cabinet business, which continues to grow more than 20%. Personal protective equipment or PPE, while still elevated compared to pre-COVID levels declined again on a sequential basis. We welcome this mix shift because the cabinet service is a more consistent revenue stream and has higher profit margins in PPE.

Our Fire Protection Services and Uniform Direct Sale businesses are reported in the All Other segment. All Other revenue was $234.5 million compared to $189.7 million last year. The Fire business organic revenue growth rate was 17.4% and the Uniform Direct Sale business organic growth rate was 44.1%.

Before turning the call over to Mike to provide additional details on our first quarter results, I'll provide our updated financial expectations for our fiscal year. We are increasing our financial guidance. We are raising our annual revenue expectations from a range of $8.47 billion to $8.58 billion to a range of $8.58 billion to $8.67 billion. Also, we are raising our annual diluted EPS expectations from a range of $11.90 to $12.30 to a range of $12.30 to $12.65. Mike?

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Thanks, Todd, and good morning. Our fiscal 2023 first quarter revenue was $2.17 billion compared to $1.9 billion last year. The organic revenue growth rate adjusted for acquisitions, divestitures and foreign currency exchange rate fluctuations was 13.9%.

Gross margin for the first quarter of fiscal '23 was $1.03 billion compared to $902.8 million last year, an increase of 13.9%. Gross margin as a percent of revenue was 47.5% for the first quarter of fiscal '23 compared to 47.6% last year.

Energy expenses comprised of gasoline, natural gas and electricity were a headwind increasing 30 basis points from last year. Gross margin percentage by business was 47.5% for Uniform Rental and Facility Services, 49.6% for First Aid and Safety Services, 48.8% for Fire Protection Services, and 37.3% for Uniform Direct Sale.

Operating income of $440.1 million compared to $394.1 million last year. Excluding last year's first quarter gain totaling $12.1 million and recorded in selling and administrative expenses, fiscal '23 first quarter operating income increased 15.2% and operating income margin increased 20 basis points to 20.3% from 20.1% last year.

Our effective tax rate for the first quarter was 14.8% compared to 11% last year. The tax rate can move from period to period based on discrete events, including the amount of stock compensation expense.

Net income for the first quarter was $351.7 million compared to $331.2 million last year. Last year's first quarter diluted EPS contained $0.09 from the previously mentioned gain and related income tax expense. Excluding the gain and the related income tax expense, this year's diluted EPS of $3.39 compared to $3.02 last year, an increase of 12.3%.

First quarter operating cash flow increased 13.8%. On June 15, 2022, we paid shareholders $97.7 million in quarterly dividends. Also during the quarter, we purchased $210.8 million of Cintas common stock under our buyback program. We continue to allocate capital in many ways to improve shareholder return. Our strong balance sheet and cash flow enable us to do so consistently.

Todd provided our annual financial guidance. Related to the guidance, please note the following. Fiscal '22 included not only the gain on sale of operating assets in the first quarter, but also a gain on an equity method investment in the third quarter. Excluding these items fiscal '22 operating income was $1.55 billion, a margin of 19.7% and diluted EPS was $11.28. Please see the table in our earnings press release for more information.

Fiscal '23 operating income is expected to be in the range of $1.72 billion to $1.76 billion compared to $1.55 billion in fiscal '22 after excluding the gains. Fiscal '23 interest expense is expected to be approximately $110 million compared to $88.8 million in fiscal '22 due in part to higher interest rates. Our fiscal '23 effective tax rate is expected to be approximately 20%. This compares to a rate of 17.9% in fiscal '22 after excluding the gains and their related tax impacts.

The expected higher effective tax rate will negatively impact fiscal '23 diluted EPS by approximately $0.32 and diluted EPS growth by approximately 290 basis points. Our financial guidance does not include the impact of any future share buybacks and we remain in a dynamic environment that can continue to change. Our guidance contemplates a stable economy and excludes pandemic related setbacks or economic downturns.

I'll turn it back over to Paul.

[Paul F. Adler, Vice President-Treasurer & Investor Relations at Cintas]

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.

Questions and Answers

[Operator]

[Operator Instructions] We'll now take our first question from Ashish Sabadra of RBC Capital Markets. Please go ahead.

[Ashish Sabadra, Analyst at RBC Capital Markets]

Thanks for taking my question. I was wondering if you could just comment on the new business trend, specifically around signing up new customers. Have you seen any changes there? And any signs of elongations of sales cycle particularly for larger customers? Thanks.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Good morning, Ashish. This is Todd. Thanks for the question. Yeah. Our new business is quite robust. We continue to be very successful in converting over no programmers into our programs in all of our businesses with the exception of fire, which obviously -- they were all -- everyone's a programmer in that business, but we're having really good success there. And we look at the total addressable market and it's still incredibly large and growing. So that's exciting for us.

But as far as the sales cycle, I haven't seen anything that would lead me to believe that the sales cycle is elongating. We've got really good momentum in our new business. I'm very encouraged by that. And as we've spoken about in the past, some of our investments that we have made are really paying off big in the form of some of our unique products in our rental line with our car hard products, our shift works and we've got a careflex time of scrubs through land out that's really successful in our unique restroom lines.

And then our First Aid business, just the breadth of products that we're offering is really helping us get in the door and provide great products and services to our customers. They're also seeing our investments and technology that we've made, whether it's our garment tracking that, is giving us a real advantage in the marketplace, our garment dispensing that we've seen.

And I've spoken about our My Cintas portal which is unique and advantaged in the marketplace. It makes it easier to do business with us and that's important for our customers and gives our sales partners confidence in walking in the door. So some really good things in -- heading in that direction.

[Ashish Sabadra, Analyst at RBC Capital Markets]

That's very helpful color and obviously great to see that strong momentum in the top line. Maybe just on the margins, the question around energy looks like, oil prices might be rolling-off here or at least the fuel prices may be rolling-off, but the natural gas prices are going up. How should we think about those puts and takes on the energy front for the rest of the year? Thanks.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yeah. So when you think about our energy spend, certainly, it's up over where we were a year over prior. It's down 10 basis points sequentially. Trying to anticipate exactly where that's going to head is challenging. Certainly, but I can tell you this, we are focused on efficiencies that we can drive in our business that will lower our needs for natural gas and lower our needs for gas at the pump. and we're leveraging those and that's helping us.

That helps us with our CO2 emissions and it helps us with our efficiencies in our business and our spend. And we're confident we can continue to make strides there. So that's where exactly natural gas prices will go this winter, what's going on in Europe and other areas. It's tough to tell for sure, but we'll manage through it and we see opportunities to improve in our business and we're leveraging that.

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Ashish, I might add that right around 60% of our energy spend is the gas, or -- gas and diesel and the remainder is electricity and natural gas. So the natural gas is a smaller components of that energy spend. More of it is the price of the pump, which as you suggested is coming down.

[Ashish Sabadra, Analyst at RBC Capital Markets]

That's very helpful color. Thanks again.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

We will now take our next question from George Tong of Goldman Sachs. Please go ahead.

[George Tong, Analyst at The Goldman Sachs Group]

Hi. Thanks. Good morning. In the quarter approximately what percentage of new business growth came from the no programmer market?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Good morning, George. This is Todd. The majority of our accounts are -- come from no programmers. So that is -- that trend has been consistent over the years and continues. And in a marketplace where it's still difficult for employers to find people to work, offering a value this and the way we handle it with uniforms is attractive for them. So it's another benefit for customers and they see that as an opportunity to attract their employees and retain their employees and we have one heck of an offering when it comes to that, that makes it really attractive for people. So I'd say those trends continue as they have in the past.

[George Tong, Analyst at The Goldman Sachs Group]

Got it. Can you provide an update on uniform demand trends from the healthcare vertical?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yeah, certainly. So the healthcare vertical is a very attractive vertical for us. It's growing nicely. Demographics are such in the United States and Canada that demand will continue. And we're seeing -- we have some unique offerings in that area with garment dispensing and our unique scrub line that makes it attractive. There's certainly other items that are -- that we rent into the healthcare market, whether it be an acute or non-acute. But we really like what we're seeing there from that demand.

And I'll give you one example of a hospital that about six months ago, we sold a scrub rental program into that account. And it was a nice -- very nice sized customer that you would recognize a name. In that case, the nurses that we were providing the program to, they were wandering the products at home and the nurses voiced a concern about safety. Meaning, hey, what am I taking home? Am I wandering it? Am I wandering it correctly? And in that case, they chose Cintas because of a few things.

One is, our technology that we've deployed that's unique that allows us to manage inventory for them, which provides the requisite access to the product, which is really, really important. And also helps control their costs based upon how we manage that inventory. But also improves the safety aspect of it, so separate from being an employee benefit, because those what I'll call potentially contaminated goods or scrubs. They don't go home. We laundry them appropriately via our hygienic process, hygienically cleaning process, which allows them to have the confidence that their process correctly and when that it's improved safety.

And just as an anecdote, I mentioned that was about six months ago, just recently, we sold a microfiber wipe rental program to that same hospital. And so they use microfiber wipes in many ways, but the most obvious one is when they're cleaning guest rooms or patient rooms, we should say. In this case, that particular hospital they were purchasing those wipes and then they're having the, I'll call them hospital employees or EBS type folks that were cleaning those on their on-premise laundry.

And in that case, they chose Cintas because it was able to -- we were able to reduce their labor costs. They're having trouble getting access to labor. And then again, we're processing those in a manner where they can have great confidence that they're processed correctly with a hygienically clean process. So you asked your original question, George, was about uniform demand in hospitals, which is quite good. But it also, there's so much that we can provide to those hospitals. And I just want to give one example to just give a little color around that.

[George Tong, Analyst at The Goldman Sachs Group]

Very helpful. Thank you.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

I will now take our next question from Andy Wittmann of Baird. Please go ahead.

[Andy Wittmann, Analyst at Robert W. Baird]

Great. Thanks for taking my questions. I guess, Mike, I just wanted to talk a little bit about what is implied in the guidance here. Maybe couple of different ways to think about that. But how much conservativism is baked into the guidance? And I made a couple of comments in the prepared remarks. Is there any change maybe sequentially to the guidance the way you're factoring in the macro outlook? And maybe any leading indicators that you can give us -- that gives us confidence that the economy is performing at the rate that you think it is?

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Well, so let me start, Andy, with the guidance. The guidance implies and we're 60 days past when we gave the initial guidance. The guidance implies really good growth through the rest of the year. But as you know, we do face some tougher comps as we saw the business pick up last year throughout the year.

And so we would expect a little bit of deceleration from the growth levels of where we are, but still healthy growth and ending the year in a range of 9% to over 10%. And we like the momentum of the business today and our expectation right now is that we're not seeing any change in the value that our customers are seeing and we're not changing -- we're not seeing any change in the way in the economy, I'll say.

Now -- maybe I'll flip to margins briefly. Our margin expectation remains that we will see margin improvement during the year and that range that we provided certainly contemplates that margin improvement even in a pretty challenging type of economic environment. So the guidance is a little bit better than we gave 60 days ago, part -- because of the first quarter, part because of the momentum that we see in the business.

Now as it relates to -- trying to dissect what the economic picture is going to look like for the rest of the year, look, that can be pretty difficult, right? I mean, there are -- some who say we may be in a recession today. There are some who say we may be in a recession early '23. Some who say, we may be in a recession late in '23. The Fed has come out and said GDP for '23 is going to be 1.2%. It's hard to predict what we're going to see in the economic picture as we move forward.

But what we know is that the momentum in our business today is really good. The value proposition that our customers see and our prospects see, they're reacting very positively to it. And because of that and many other factors, we believe that momentum can continue along with healthy margins. And that's what we've given you in our guidance. Does that help answer that question a bit?

[Andy Wittmann, Analyst at Robert W. Baird]

It does. Thank you for that. I guess, I wanted to -- then follow-up with a question on, I guess, overall customer retention levels. Considering that you're getting above historical averages in price increases, I thought maybe it would be helpful to comment on that. And you guys have talked about the sales momentum in a couple of different ways, but if you look at sales productivity on a per head basis, is that metric up on a year-over-year basis as well?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Andy, thanks for the question. This is Todd. First off on retention, yeah, retention is very good. We like where that is. We like the momentum around that. We're organizing around it appropriately to make sure that we're meeting and exceeding our customers' demands. And we like our -- the product and service offering that we have and the customers find it attractive.

I mentioned some of the products and the technology that we have that are unique and the customers like it. I think they also like our approach that we took over the past couple of years about being really flexible and empathetic with them as they were going through, -- what they went through the various businesses through calendar '21 and calendar '22, -- '20and '21, I should say, with the pandemic.

So I think that was -- that is benefiting us because they saw that we were -- we understood what they were challenged with and we pivoted to provide them what they needed instead of just telling them, hey, here's what you contracted to buy. So I think all that is paying off. As far as productivity in new business, yeah, we like it. It's up and we are -- certainly, we love our sales force.

We think they're well trained, well positioned when sales partners have confidence in the products and the technology and the services that they're going to provide, that confidence is powerful and it's showing itself in productivity and we like that. We're also deploying up types of technology, via our investment with SAP, that's paying off in a number of ways.

I'll just give you one as it relates to sales, which is investing in technology that allows for what I'll call best next prospect for a sales partner. Meaning instead of just calling blindly on businesses, we want to drive to our sales team who will be the next best prospect to call, which through analytics, we can tell them where to spend their time. And that's better for the partner, that's better for our company, again that provides more confidence. And yeah, so those types of investments are paying dividends for us.

[Andy Wittmann, Analyst at Robert W. Baird]

Great. Thank you.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

We can now take our next question from Tim Mulrooney of William Blair. Please go ahead.

[Tim Mulrooney, Analyst at William Blair]

Yes. Good morning. We know energy was a slight headwind to margins in the quarter relative to last year, but gross margins were only down 10 basis points. So I was curious, how some of the other cost buckets are trending? How are labor costs trending? Were those a headwind or a tailwind to margins? And anything else big to point out here like maybe materials and supplies?

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Tim, maybe I'll start on that. From a gross margin perspective, you're right. We're down 10 basis points from last year in a period where total energy expenses are up 30 basis points. We're up 190 basis points sequentially and so we've seen some nice improvement there. And look, when you think about that rental number of 47.5% that's a really good gross margin for us.

We've only been higher than that a few times and that certainly is a much greater gross margin than we saw pre-pandemic. So we like the -- where we are in that space. We like the sequential improvement in the gross margin, which is pretty good. And we're doing it while we have -- we've seen such good growth in volume over the course of the last year and we're able to be pretty flat overall in gross margins while we're investing in the business.

So in other words, that volume growth over the last 12 months has, we certainly created the need for additional capacity, particularly in our laundry facilities and we're investing as we should because we certainly want to make sure we have the capacity to serve the customer. And so nothing -- I would say nothing unusual to point out in there other than we continue to make the progress that we want to make.

The only other thing I might say about that gross margin is, we're seeing an all-time high in our First Aid and Safety business. And we continue to like the way that business is trending and the mix back towards that First Aid business that we love so much. Todd mentioned that the First Aid part of that business is over 20% growth still. And we've seen some really nice movement there. So again, nothing real specific to point out other than making good sequential progress and certainly continuing to invest for our future growth.

[Tim Mulrooney, Analyst at William Blair]

Yeah. Thanks, Mike. I guess my follow-up will just stick on that point. The First Aid and Safety gross margin really stuck out to me in the quarter. I mean, you're almost at 50% gross margin in that business, well above what we normally see there. Are there any extraordinary items to call out there that help drive those strong results that wouldn't necessarily repeat moving forward? Just trying to understand how to think about gross margins in First Aid moving forward as we model out the business for the rest of the year?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Sure. Tim, it's Todd. We're proud of the gross margin improvement that we've made in the First Aid business. It is reflective certainly of the shift of the mix of the business. But I wouldn't say that there's anything that is out of the ordinary, where you'd say, oh, my goodness. Is there something that a one timer? So, no. Now that being said, we're -- certainly there will be puts and takes of the First Aid business gross margin throughout the year, don't think of it as a linear progression upward. It's -- we're making investments. We're growing that business really attractively.

We are certainly leveraging -- trying to leverage as very much as best we can. The revenue growth that we're getting, but we've got to -- we've -- as Mike pointed out in all of our businesses, we've got to invest to meet the demand. And we're doing exactly that and trying to do it as intelligently and as efficiently as possible. But we're really happy with the demand levels that we're seeing and make sure we're positioned to meet those demand levels.

[Tim Mulrooney, Analyst at William Blair]

Okay. That's really helpful. Thank you, guys and congrats on a nice quarter.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you, Tim.

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Thank you.

[Operator]

We can now take our next question from Manav Patnaik of Barclays. Please go ahead.

[Manav Patnaik, Analyst at Barclays]

Thank you. Good morning. I can appreciate, obviously, all the trends are very strong today. As you said, no economic weakness you're seeing in your businesses, but maybe you can help us with typically if that does start impacting your customers, like, how quickly do you see it, how quickly do they react? And I guess what do you do in response to that?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yeah. So Manav, good question. We are not seeing it in our customer base today. And as a reminder, -- as of Friday, there'll be four months into our fiscal year. And will we see it how well -- what's this recession? Are we in one, as Mike said, is there one coming in the first half of '23, the back half? We're not trying to predict all that, but we are staying acutely aware, but we're positioning ourselves to make sure that we can grow in all types of economic cycles.

And as a reminder, we've grown in 51 out of the last 53 years. The only exception being the great recession. We certainly hope that any recession that comes is not as severe as what that was. And so what I'll call in, whatever the traditional type of recession, if that comes, then we expect good performance. We expect to grow. We have traditionally grown in multiples of GDP and jobs growth in the past. Mike spoke of our products and services are highly valued. You think about cleanliness, safety, image and compliance. Those are buying motors that are stronger today than they were in the past, certainly stronger than what they were even pre-pandemic.

Our products and services are more diversified today. Our customer base is more diversified today than it was in the past. Today, we're 70% services and 30% goods producing. So that diversification we think will help us. And when you think about NAICS codes, we have no three digit NAICS codes that is greater than 10%. So again, a really nice diversification there.

We have also invested as we've talked about in the past calls in our vertical sales approach which we think gives nice diversification into when you think about government and you think about healthcare, higher education, those types. We've spoken about our momentum that we think is really, really good. And also our strong cash flow, we think that will allow us to be opportunistic as we -- whenever we are into a recession if that is today or in the future, we're going to be well positioned to make sure we're successful.

[Manav Patnaik, Analyst at Barclays]

Okay. Got it. That's helpful. And then maybe Mike, if you could just remind us of your mix on the debt side between fixed and floating, whether you hedge just as we track these interest rate increases?

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Sure. We have -- as of the end of August, Manav, we've got about $500 million in commercial paper or other short term variable debt. And the rest of our debt is fixed or senior notes. We do have some of our 27 maturities the interest rates locked on those. Those are right now, as you can imagine, a fair amount in the money So that's where we are today and look that the -- we like that, we like a little bit of that short-term debt because it gives us optionality. We can pay that down if we feel like we want to or we can certainly have more space to use that if we needed to.

[Manav Patnaik, Analyst at Barclays]

All right. Thank you.

[Operator]

And we can now take our next question from Andrew Steinerman of JPMorgan. Please go ahead.

[Andrew Steinerman, Analyst at J.P. Morgan]

Hi. It's Andrew. I just wanted to get a quick thoughts from you about organic revenue growth for the balance of the year from kind of each First Aid, Fire, Uniform Direct. Those had particularly strong first quarters. I definitely heard your general comments about tougher comps. And like, do you think each of these three should be double-digit organic growers this year?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Andrew, thank you for the question. When I think about each of our businesses, we don't give guidance based upon each of them individually, but I'll just provide some maybe some top line thoughts. I'm really -- I haven't done the calculus on what it would be for the year, but I'm just thinking about Qs two through four for each. I would think about from rental, Fire and the First Aid business all being high-single digits of the balance of the year.

Keeping in mind that there was some PPE in the First Aid business in Q3 which will provide a tougher comp for sure. And then in our Uniform Direct Sale business, we're going to be up against much tougher comps. So I would think of that from high-single to flat, maybe even negative in Q4 based upon the significant comps that we're up against there, which is obviously a little bit more lumpy business.

[Andrew Steinerman, Analyst at J.P. Morgan]

Just say that last part again about Uniform Direct Sale, high-single digit. And then you said flat, just -- you were talking about two through four. So just say the last part again about Uniform Direct Sale.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yes. So when you think about Uniform Direct Sale business, again, a lumpier business, high single to -- from Q2 through Q4. Think about high-singles down to closer to flat to maybe even negative in Q4, due to sales growth due to the significant comps that will be up against on the back half of the year.

[Andrew Steinerman, Analyst at J.P. Morgan]

Makes sense. Thank you so much.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Great. Thank you.

[Operator]

And we can now take our next question from Faiza Alwy of Deutsche Bank. Please go ahead.

[Faiza Alwy, Analyst at Deutsche Bank Aktiengesellschaft]

Yes. Hi. Thank you. Good morning. I guess, I'm curious, like what has gone better than what you expected, when you first gave the guide a couple of months ago, especially as it relates to revenues. I know you mentioned better pricing and I'm curious if the pricing update has been better than expected or is that better new business? I know you mentioned the healthcare vertical in particular. So just more perspective on like what you think really drove the outperformance, specifically in the rental business?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Great. Faiza, thanks for the question. It's Todd. I'll start if Mike you want to chime in. There's many contributing inputs to our positive growth that we're seeing. New business is quite good as we spoke about, but retention and penetration is very attractive as well. We continue to improve upon our cross sell. And as you mentioned, pricing is certainly playing a larger role than it did historically, as it should because of the levels of cost increase that we are seeing via whether it's labor or material cost and what have you.

So I think just generally speaking, we like the key inputs that we're seeing. I mentioned earlier our diversification into those various businesses, verticals, et cetera., they're all -- we like the momentum we're seeing in all those, so pretty widespread.

[Faiza Alwy, Analyst at Deutsche Bank Aktiengesellschaft]

Great. Thank you. And then just a follow-up on the labor environment. I don't know if you're seeing some easing in the environment in your business at this point. And I'm curious how you think about that going forward sort of, is that as a labor environment eases, is that a benefit for you? Or is that maybe more of a headwind from a competitive perspective?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Good question on labor. I'd say, easing a bit, but that's relative. It is still a very challenging environment. But maybe not as quite as challenging as it was six months ago, eight months ago, but still quite challenging. And we are in constant pursuit of a tracking and retaining the very, very best people. We think that gives us competitive advantage in the marketplace. So when we look out and say, okay, what does that mean to us? We're constantly in pursuit of that.

So any easing of the labor market would certainly be welcome from a standpoint of making a little bit easier to run at lower RPMs. But here's what I know is we -- our team figures it out and they have -- they are staffed at the appropriate levels to meet our customers' demand. They've done one heck of a job in fighting through all these challenges over the past couple of years to make sure that we're positioned to be successful. So whatever the environment, our team will figure it out. We've shown that they'll be in the past. We'll pivot appropriately, but -- so we'll manage through it.

[Faiza Alwy, Analyst at Deutsche Bank Aktiengesellschaft]

Great. Thank you so much.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

We will now take our next question from Heather Balsky of Bank of America. Please go ahead.

[Heather Balsky, Analyst at Bank of America]

Hi. Good morning and thank you for taking my question. On the new customer growth front, could -- you already touched on healthcare earlier in the Q&A, but where else are you seeing some of the momentum? Are there additional verticals where you're seeing outside growth or you're targeting verticals you haven't been in the past? It'd be great to get color on that. Thanks.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Heather, thanks for the question. Again, our experience is very broad in our successes that we're seeing. I'll just give you one another example that might provide a little color. In one of our verticals, where we're calling on the government sector. There's one particular city that I won't mention, but you'll know the name of it. About a year ago, we sold a uniform program into that city. And as an example there, that was into the sanitation, transportation, parts and recreation type departments.

And in that case, they were using a local provider before we took over that account. And they chose us in that case because they liked our garment offering was better, meaning they thought we had better, more attractive garments that their employees wanted to wear. Our garment tracking technology help them to reduce costs, meaning less lost garments and what have you.

And then as I mentioned earlier, our investment into our My Cintas web portal makes it may be easier for them to do business with us. So which reduces their administrative time and just helpful for them. So that was about a year ago and then, If you fast forward just recently, we sold them a First Aid cabinet service to all those departments and even more municipal buildings. And in that case, previously they had ordered all their first aid products online. So they were a no programmer. They were ordering it from whomever online and then they were essentially doing all that work and filling those candidates themselves.

Inquisidentally, the sales lead for that opportunity came from our uniform service provider. So while they're the uniform service provider was speaking to the customer and they said, hey, we need help here. So the uniform service provider pass it on to our -- the appropriate person in our First Aid service provider.

In that case, they chose us because, again, a better management of the products and we're able to help them manage the products better, improve their compliance, reduce their costs and remove their need to administer the program. So you think about what businesses are challenged with. In this case, it was a city government, but it's still, they're still running it as a business where they have to meet their customers' demands and their employees' demands.

And I think another example of just how we are growing our business and why it's attractive for businesses, sticky, good retention, good cross sell and that shows itself in new business. Hopefully that color helps a little bit.

[Heather Balsky, Analyst at Bank of America]

Yeah. Thank you for that. And then just a question on pricing. Can you just walk us through where you are in the process of taking, I guess, this outsized pricing you've been taking? When did it start? Kind of when do you start to anniversary it? Just trying to think through the flow through as we progress over the next few quarters.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Well, Heather, pricing is a local subject. It's a customer by customer subject. Meaning some businesses are doing better than others. And -- but as we look at that, when inflation kicked in to much higher degrees than that required us to make sure that our price adjustments were higher than historical as well.

So you can think of about it that way when inflation was -- went to above historical levels. That's when we adjust to pricing at above historical levels. And as far as what that means moving forward, that will depend upon the -- what inflation does moving forward. So I don't have a crystal ball as it applies to that or a recession what have you, but we're paying very, very close attention to all those inputs and we'll manage it appropriately.

[Heather Balsky, Analyst at Bank of America]

Thank you.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

We will now take our next question from Seth Weber of Wells Fargo Securities. Please go ahead.

[Seth Weber, Analyst at Wells Fargo & Company]

Hi, guys. Good morning. I actually had a pricing question as well, kind of a similar question. So, Todd, I guess I'm trying to understand if how much of the price increases that you guys have been pushing through are just purely tied to inflation and how much of it is, since I was just trying to get more for the value prop that you're off offering today? So I'm trying to understand, will pricing revert back to its traditional level if inflation receives? Or do you think that pricing can be structurally higher for Cintas just based on the greater value that you're offering to your customers kind of today versus history, that makes sense?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yeah, Seth. It's a fair question. As I think about our customer base, we're such a broad customer base. So some of them, we have contractual commitments, some of them we have the ability to adjust prices closer to inflation and what have you. So it's very, very broad and it really depends on the particular customer and the health of that customer as well. But here's what I can tell you is that we take a long term approach. We don't think about our customers and quarters or fiscal years, we think about them in over decades. And that approach has really paid-off big dividends for us.

Now, we are constantly trying to improve the value that we provide to our customers. That being said, when inflation is at the levels it's at, it requires us to adjust prices at above historical. When inflation comes back down and we certainly hope and expect that that will occur. Then I think you can think of our price adjustments to be back closer to more historical. We're now -- am I constantly trying to improve the value to our customers? Absolutely. That pursuit will be in perpetuity and the marketplace determines how that pricing is handled appropriately.

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Seth, I might add two things. One, you bring up kind of the structure of our pricing and we're generally the highest price relative to our competition in the space. So in other words, we don't leave with price generally. We believe that our products, our service, they are better and that generally means we are at higher price points than our competition. And I don't expect that that would change.

As Todd said, we are continuing to look for ways of even improving that value more in the future. But I don't see that type of pricing changing because of the inflation going up and down. We believe that we can command the best prices because our products are better like, car hard and other products like that and our service is just better.

The other thing I might add is, our pricing is, as Todd said is customer by customer and local and it's not necessarily a -- we have to offset or we look to offset inflation immediately. Generally speaking, we want to do the best for our customers and continue to add the right value, but we also know that given the way our cost structure works, we don't have to necessarily immediately offset inflation.

We get, for example, the products that we rent in our rental business, we get to amortize them, right? And so if we do have to take a cost increase, we get -- we certainly get visibility before that hits our P&L because that has to go through the manufacturing process, then it gets to our locations and then it amortizes over a period of time. And so we can we can have multiple price increases before that hits our P&L.

And that ability to anticipate and manage our cost structure as well as our pricing, it's reflected in the fact that even in this pretty darn difficult environment, we've been able to increase our margins year-over-year, certainly, excluding those one-time gains, but we've been able to continue to increase our margins during that period of time.

So I just give you that color to say, we are very thoughtful about the way we price and we are thoughtful about the way we anticipate the costs within our cost structure. And it works because we're able to increase our margins in a pretty difficult inflationary environment in each of the last four quarters.

[Seth Weber, Analyst at Wells Fargo & Company]

Yeah. No, it makes total sense, Mike. I appreciate it guys. That's super helpful and that's really all I had today. Thank you.

[Operator]

We'll now take our next question from Shlomo Rosenbaum of Stifel. Please go ahead.

[Shlomo Rosenbaum, Analyst at Stifel Nicolaus]

Hi. Good morning. Thank you for taking my questions. It's pretty noticeable that the cost of goods sold is up only like $10 million sequentially. But when I look at the SG&A, it's up like $46 million. And usually when you have some kind of inflationary prices, I would have thought it'd hit the COGS more. Maybe you could explain to us what the changes were in SG&A and was there some kind of significant investments in production or anything like that? And maybe if you can bring it down to kind of the unit level?

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Well, Shlomo, I'll speak to the SG&A piece of this. Yes, we did have some sequential increase. But Shlomo, if you look at going back to -- I've got going back to fiscal '15. Our first quarter SG&A is usually the highest of the year. I'll throw out the pandemic impact a year. But our first quarter is usually the highest SG&A quarter of the year and that's been consistent for a number of years. And that's simply because of some things like, we have higher payroll taxes when our equity compensation vest at that period of time.

It usually happens in the first quarter. We tend to have a little bit more stock options that create more payroll taxes. We tend to have some beginning of the year meetings and other things that happen. But year-over-year, if you pull that gain out that we've been talking about, our SG&A is down 40 basis points. And so we like -- we do like the movement of that SG&A.

And gosh, if you go back to pre-pandemic Q1 of 2020, we're down almost 300 basis points. If you go back to 2019's SG&A were down 260 basis points. My point Shlomo is, this is not unusual for us to have a first quarter higher SG&A because of just the way that our business works and the timing. But year-over-year, we continue to make really good performance in that. And in this case, down 40 basis points.

[Shlomo Rosenbaum, Analyst at Stifel Nicolaus]

Okay. Thank you. And then maybe you can also talk about the higher revenue kind of translated into margin for two of the units, but for kind of the other unit, it didn't look like it's translating exactly the same way. Is there something that was -- is there a mix item in terms of what was being sold over there? And then just maybe you can just touch on your expectation for cash flow through the year with such strong revenue should we expect there to be a working capital drag. So we wouldn't necessarily see revenue grow the same way that we would see earnings grow.

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Shlomo, I'll talk to the All Other first. I'm not sure, if you're talking year-over-year that gain that we've referred to a number of times is in the All Other. And so you have to make sure that you're stripping out that gain 14.7% for the quarter for us that is a pretty good quarter.

But as Todd mentioned a little bit ago, that Uniform Direct Sale piece that can tend to move up and down a bit and be more inconsistent from quarter-to-quarter and that's a bit of what we've seen in this quarter. So once you pull out the gain from last year where we had that outsized operating margin in All Other. We're at a pretty good spot at 14.7% and it more than anything is attributable to that lumpiness in the Uniform Direct sale business.

As it relates to our cash flow, look, we like where the cash flow is where our operating cash flow is up 13.7% year-over-year. Free cash flow is up 7%. And look from quarter-to-quarter, there can be puts and takes. But generally speaking, our cash flow is really good and I expect that we'll see a continued very good conversion from net income to operating cash flow.

Now, when we grow and we've been growing quite nicely, we have always been a bit of a drag in working capital because our AR tends to go up as we grow. Our uniforms in service and other items in service tends to grow -- go up as we grow and that certainly has happened. But we're still turning that into really good cash flow and I would expect that that's going to continue for the rest of the year.

We're going to probably be a little bit higher in capex during this fiscal '23 year because we've -- again, we've kind of come from a pandemic period where we didn't need to grow capacity and we've really seen some nice growth over the course of the last -- more than fiscal year. And that certainly means we do some investing. And so you're going to see a little bit of an increase in capex, but right in the range where we've guided to that 3% to 3.5% of revenue.

[Shlomo Rosenbaum, Analyst at Stifel Nicolaus]

Great. Thank you.

[Operator]

And we can now take our next question from Scott Schneeberger of Oppenheimer. Please go ahead.

[Scott Schneeberger, Analyst at Oppenheimer]

Thanks very much. Good morning, guys. I mean, kind of go back to the recession question and the essence of the question is going to be visibility. It's been asked a few times on the call, but your guidance, your quarter is obviously quite strong. The guidance is certainly ambitious. And I view you guy has generally pretty conservative. So things must look really good to you right now and through the end of the fiscal year. So no one have kind of asked this, but I want to delve in a little bit deeper.

When do you see when you're working with your customer or something like going back to past recessions. What are the first signs you see? How do they manifest? And what type of visibility do you have into OOK that's going to affect our numbers, weeks, months, quarters later. If you could just tell us kind of going back to pass through session, how that takes shape? Thanks.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Scott, this is Todd. Thanks for the question. Mike, certainly if you want to chime in. When we think about, again, are we in a recession technical? It's one coming in early '23, late '23 how severe we don't know those items, but we are watching it very closely. When you think about our customer base, how might it show up? We'll customers if their demand is being impacted then they're going to look for ways to cut their costs. Is that in getting a no look at their P&L and say, okay, what's the biggest things I can move on?

And frankly, we're not usually top of their list. So -- and the reason being is because our spend per customer is pretty small. But that being said, we'll -- will they reduce their needs for certain services, reduce quantities of products that they need. Certainly those types of things can happen if their demand is being impacted. So those are the items that we look for is, our customers reducing their needs because their demand of their business is such that they don't need as much. So I'd say that would be one of the certainly bigger categories that we look for. Mike, any other thoughts, but those are the first one that came in mind.

[J. Michael Hansen, Executive Vice President and Chief Financial Officer at Cintas]

Yeah, I think that's true. We may see some of those kinds of signs. We may see a couple of our customers go out of business depending on the type of recession. But the other thing that I think is really important is we've grown through lots of recessions in the last 50 years. And we have also sold a lot of new business through every recession. And so even if we start to see some signs that the customers are paying a little bit more attention to their spending. We know this that we're not asking them generally to spend new money. It's spend it with us and we will help them with our programs to reduce their own work content.

In other words, they can -- they find their people can do more with less because we're able to take some work away from them and we're not necessarily asking them to spend new dollars. So we -- look, we're going to be paying attention to all different kinds of things within the economy, but we know this. We're going to sell a lot of new business. We're going to sell the no programmers.

We're going to help our customers reduce their own work content. And that's why we feel, we not only do, we love the momentum that we have, but as we look forward, that value proposition is still resonating very, very well. We've said that a number of times and we don't see that changing And so we feel pretty good and we generally -- our guidance is a reflection of that and we like where we're headed.

[Scott Schneeberger, Analyst at Oppenheimer]

Excellent. Thanks guys. That sounds good. I think a good follow on there. You've alluded to M&A, but we haven't really discussed it on this call. How is the environment right now? Are you seeing more opportunities or is that pretty steady? Any commentary on multiples? Is that something that's what more attractive, less attractive? Thanks.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yeah, Scott. This is Todd. Our deal flow is good. We love our balance sheet, who love our position in the marketplace. That being said, those M&A type of opportunities, they -- tough to pay some, toughed there are various items that cause things to flip the switch for someone to sell their business. But I can tell you this, we're really well positioned. Love our balance sheet, love our team and the ability to manage through any M&A. And we think that that's going to be an opportunity for us in the future and we're well positioned for it.

That being said, again, it's tough to pace them, but deal flow looks good and I don't see anything that's all that different from a multiple standpoint in the marketplace. So we're interested in any and all opportunities from an M&A standpoint and we'll continue to push for those.

[Scott Schneeberger, Analyst at Oppenheimer]

Thanks, Todd. Excellent. I'll turn it over.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

We can now take our final question from Toni Kaplan of Morgan Stanley. Please go ahead.

[Toni Kaplan, Analyst at Morgan Stanley]

Thanks. I wanted to ask a longer term margin question. If I look back about two years ago, your EBITDA margin like really meaningfully stepped up to mid-20s. But at the beginning, I think you're benefiting from travel, reduced travel during the pandemic and healthcare costs. You've really been able to keep it at that level. And I know you talked about adjusting your cost structure at the beginning of the pandemic, but basically what type of expenses have you been able to adjust so that you can stay at this mid-20s EBITDA level. Just how sustainable is it? It seems like it is, but wanted to just get some additional color there.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Yeah, Tony. It's Todd, you're absolutely correct. And when we look forward, we see incremental margins. We've talked about 20% to 30% and we see that in our future. And we are leveraging certainly the top line very nicely. We manage our variable costs. I think quite well, the team is very, very good at that. But we're also getting efficiencies from some of our digital transformation that we've talked about in the past. You see that certainly energy is a big subject today, but we've talked about our Smart Truck proprietary routing technology that's helping us reduce idle time and drive time, which obviously helps with energy spend, but it helps with CO2 emissions as well.

And one of the things, we talk about around here is that we don't make money when the wheels are moving on our trucks. So getting those efficiencies is very important. We're extracting other efficiencies via our investment with SAP, with our inventory control programs that are allowing us to get better reuse of our products in our stockrooms, which also helps improve turnaround time for our customers. We think it's very, very important which gives us an advantage in the marketplace.

I mentioned in our last call, we have an operational excellence dashboard that provides us better transparency into the efficiency levels at each of our production facilities. So that is significant, right? So we're able to understand the efficiency levels of our facilities not by having to be there in person every day, but by understanding the metrics of our operational excellence dashboard in real time. So I guess it's a blessing that we have those opportunities to improve. It's frustrating that we have opportunities to improve, but we're focused on improving those and extracting those efficiencies.

So that will allow us to continue to provide good incremental margins separate from the items that I mentioned before with some of the other technologies that we deployed with making it a better win for customers and how they're doing business with us. So yeah, as we look forward, we're going to continue to those efficiencies and provide what we think are attractive incremental margins.

[Toni Kaplan, Analyst at Morgan Stanley]

Great. And on a more sort of current basis, any changes to contract structure, changes in contract lengths, any increasing the minimum thresholds for clients, anything to call out there?

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Tony, I would say, it's nothing out of the ordinary, certainly, we take a very long term approach with our customers. They take a long term approach with us and we make sure that, that we're positioned to meet their needs and exceed them and provide products and services that they really value. And so that's what we're doing in the marketplace and that tends to show itself in -- I'll just call it long term relationships. Others might call those contracts, but I call long term relationships with our customers.

[Toni Kaplan, Analyst at Morgan Stanley]

Thanks a lot.

[Todd M. Schneider, President & Chief Executive Officer at Cintas]

Thank you.

[Operator]

This concludes the question-and-answer session. I would now like to hand the call back to Mr. Paul Adler for closing remarks.

[Paul F. Adler, Vice President-Treasurer & Investor Relations at Cintas]

Well, thank you for joining us this morning. We will issue our second quarter of fiscal '23 financial results in late December. We look forward to speaking with you again at that time. Have a good day.

[Operator]

[Operator Closing Remarks]