Cintas Corporation — Form 10-Q Summary
Business Context and Reporting Period
Cintas provides uniform rental and facility services, first aid and safety products and services, fire protection services, and direct-sale products primarily in North America. The filing covers the three and six months ended November 30, 2016, Cintas’ fiscal 2017 second quarter and first half. The filing was signed January 6, 2017.
The principal operating segments are Uniform Rental and Facility Services, First Aid and Safety Services, and All Other, which primarily includes Fire Protection Services and direct sales. Shred-it and Storage are presented as discontinued operations.
Key Financial Metrics
| Metric | Three Months Ended November 30, 2016 | Three Months Ended November 30, 2015 | Six Months Ended November 30, 2016 | Six Months Ended November 30, 2015 |
|---|---|---|---|---|
| Revenue | $1,296.9 million | $1,219.1 million | $2,591.1 million | $2,418.0 million |
| Operating income | $202.9 million | $200.3 million | $409.8 million | $385.9 million |
| Operating margin | 15.6% | 16.4% | 15.8% | 16.0% |
| Income from continuing operations | $123.5 million | $115.5 million | $261.5 million | $221.7 million |
| Net income | $140.4 million | $345.1 million | $278.5 million | $445.3 million |
| Diluted EPS from continuing operations | $1.13 | $1.03 | $2.39 | $1.96 |
| Diluted EPS | $1.29 | $3.06 | $2.55 | $3.94 |
| Cash flow from operations | Not separately provided | Not separately provided | $301.7 million | $265.0 million |
Revenue increased 6.4% in the quarter and 7.2% year to date. Organic revenue growth was 5.7% for both periods. Uniform Rental and Facility Services revenue rose 7.2% in the quarter and 6.9% year to date; First Aid and Safety Services revenue rose 3.6% in the quarter and 13.4% year to date, with the year-to-date increase substantially affected by acquisitions.
Income from continuing operations increased 6.9% in the quarter and 18.0% year to date. The effective tax rate on continuing operations was 34.9% in the quarter and 31.6% year to date, compared with 37.4% and 37.3%, respectively, in the prior-year periods. The year-to-date rate benefited by approximately $19.6 million from adopting ASU 2016-09.
At November 30, 2016, cash and cash equivalents were $143.6 million, compared with $139.4 million at May 31, 2016. Current assets were $1.60 billion and current liabilities were $748.8 million. Total debt was approximately $1.11 billion, consisting primarily of $1.05 billion of senior notes and $66.0 million of commercial paper.
Six-month capital expenditures were $155.2 million, compared with $121.8 million in the prior-year period. Net cash used in investing activities was $92.0 million, and net cash used in financing activities was $203.1 million. The company paid a $250.0 million senior-note maturity, issued $66.0 million of commercial paper, and repurchased or acquired shares for approximately $19.2 million.
Material Changes Versus the Prior Comparable Period
- Continuing operations improved, but reported net income and total EPS declined because the prior-year periods included substantial gains from the sale of Shred-it and Storage.
- Current-quarter net income from discontinued operations was $16.9 million, compared with $229.6 million in the prior-year quarter. Year-to-date discontinued-operations income was $16.9 million, compared with $223.6 million in the prior-year period.
- Uniform Rental and Facility Services gross margin improved to 44.7% in the quarter and 45.3% year to date, up 80 and 100 basis points, respectively. However, selling and administrative expenses increased, reducing the segment’s quarterly income-before-tax margin by 50 basis points.
- First Aid and Safety Services gross margin improved to 46.1% in the quarter and 45.9% year to date, primarily from sourcing synergies and warehouse leverage associated with the ZEE acquisition. Higher selling and administrative expenses restrained segment profitability.
- Selling and administrative expenses increased 11.7% in the quarter and 11.1% year to date, reflecting higher medical costs, investments in an enterprise resource planning system, a national branding campaign, and sales resources.
- Net interest expense declined to $13.2 million in the quarter and $27.3 million year to date, primarily because the company replaced lower-rate commercial paper and cash funding for the $250.0 million senior notes that matured June 1, 2016.
- The company adopted ASU 2016-09, increasing opening retained earnings by $26.7 million and reducing income tax expense by $2.4 million in the quarter and $19.6 million year to date. The adoption produced a reported year-to-date diluted EPS benefit of $0.13.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
The filing does not provide specific revenue or earnings guidance. Management expects operating cash flow to remain a significant liquidity source and expects continued access to commercial paper and long-term debt markets, subject to credit ratings and market conditions.
Cintas agreed to acquire G&K Services for $97.50 per share in cash, representing an enterprise value of approximately $2.2 billion including acquired net debt. The transaction had not closed as of the filing date. It remained subject to regulatory approvals and other customary conditions. The FTC and Canadian Competition Bureau had issued additional information requests. Cintas incurred merger-related expenses of $3.3 million in the quarter and $6.1 million year to date.
The merger is expected to be financed with short- and long-term debt. The credit agreement was amended to increase the revolving credit facility from $450.0 million to $600.0 million, add a $250.0 million term-loan facility, and extend maturity to September 15, 2021. Moody’s placed its rating under review for possible downgrade following the announcement of the debt-financed merger.
Management identified risks related to regulatory approval or delay of the merger, possible divestitures, integration and synergy execution, increased leverage, credit-rating changes, customer retention, labor and medical costs, fuel and material costs, foreign exchange, cybersecurity, SAP implementation, litigation, environmental matters, tax audits, and broader economic and regulatory conditions.
Cintas received $25.9 million of additional Shred-it sale proceeds and recorded the amount as a gain in discontinued operations. Additional contingent consideration may be received, but the related gain contingency was not recorded because of uncertainty surrounding the holdback provisions.
Management stated that ordinary-course litigation and claims are not expected to have a material adverse effect. The company was in compliance with all debt covenants, and disclosure controls were effective as of November 30, 2016.
Important Facts for Investors to Verify
- Whether and when the G&K acquisition closed, the final financing structure, resulting leverage, credit ratings, and any required divestitures.
- The sustainability of organic revenue growth and whether higher selling, administrative, medical, technology, and branding costs continue to pressure margins.
- The extent to which continuing-operations earnings growth was aided by the ASU 2016-09 tax benefit and whether the benefit recurs.
- Cash conversion, capital-expenditure requirements, working-capital trends, and liquidity after funding the proposed acquisition.
- Potential additional Shred-it contingent consideration and the final resolution of tax audits, litigation, regulatory matters, and other contingencies.
- Execution of the ZEE integration and the company’s ability to realize sourcing, warehouse, and acquisition-related synergies.