Cintas Corporation — Q1 FY2011 Form 10-Q Summary
Business context and reporting period
Cintas provides uniform rental and sales programs and related business services, including first aid, safety, fire protection, document management, facility services and branded promotional products. The filing covers the unaudited three months ended August 31, 2010, compared with the three months ended August 31, 2009.
Financial performance and liquidity
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| Revenue | $923.9 million | $891.6 million | 3.6% increase |
| Operating income | $100.2 million | $98.9 million | 1.4% increase |
| Operating margin | 10.9% | 11.1% | Approximately 20 basis-point decline |
| Income before taxes | $88.6 million | $87.2 million | 1.5% increase |
| Net income | $61.3 million | $54.0 million | 13.5% increase |
| Net margin | 6.6% | 6.1% | Improved |
| Diluted EPS | $0.40 | $0.35 | 14.3% increase |
| Net cash provided by operations | $35.3 million | $144.9 million | Decline of $109.6 million |
| Capital expenditures | $48.2 million | $24.8 million | Increase of $23.4 million |
Cash and cash equivalents were $290.6 million at August 31, 2010, and marketable securities were $78.8 million, for total cash and marketable securities of $369.4 million versus $566.1 million at May 31, 2010. The decline primarily reflected $131.3 million of share repurchases, $48.2 million of capital expenditures and $47.8 million of acquisitions.
Total debt was approximately $787.4 million, including $785.7 million due after one year. Cintas had no commercial paper outstanding and no borrowings under its revolving credit facility. The company reported a 24.2% debt-to-capitalization ratio, compared with 23.7% at May 31, 2010, and stated that it was in compliance with significant debt covenants.
Material changes versus the prior comparable period
- Revenue growth was driven by 2.8% internal growth and 0.8% acquisition-related growth. Other services revenue increased 12.9%, while rental uniforms and ancillary products revenue increased 0.3%.
- Document Management Services revenue increased 30.7%, including benefits from higher recycled-paper prices; organic growth excluding the recycled-paper price effect was 10.6%.
- Uniform Direct Sales revenue increased 10.6%, and First Aid, Safety and Fire Protection Services revenue increased 3.9%.
- Rental Uniforms and Ancillary Products income before taxes decreased $24.2 million to $78.2 million. Its margin declined to 11.9% from 15.6%, primarily because of higher selling, administrative, maintenance and energy costs.
- Selling and administrative expenses increased 11.0%, including higher sales labor, $3.7 million of additional bad debt expense and $2.2 million of professional-services costs related to an enterprise-wide system conversion.
- The prior-year quarter included a $19.5 million pre-tax legal-settlement charge, net of insurance proceeds. No comparable charge was recorded in the current quarter, contributing to higher net income and EPS.
- The effective tax rate decreased to 30.8% from 38.1%, primarily because certain tax audits were closed during the current quarter.
- Operating cash flow fell substantially because of working-capital investment in accounts receivable, inventories, uniforms and rental items in service, prepaid expenses and accrued liabilities.
Outlook, commentary, risks and unusual items
Management’s strategy remains focused on increasing penetration of existing customers, broadening the customer base, expanding emerging businesses and pursuing strategic acquisitions. The filing does not provide a specific quantitative revenue, earnings or margin guidance range.
Capital expenditures included approximately $15.2 million for the enterprise-wide system conversion and expansion efforts. Management stated that existing facilities have capacity for growth. On September 27, 2010, the revolving credit facility was renewed with $300 million of capacity, an accordion feature allowing up to $450 million, and an expiration date of September 26, 2014.
The company accrued approximately $24.0 million for the Veliz wage-and-hour litigation settlement; the net pre-tax impact after insurance proceeds was $19.5 million in the prior-year quarter. The Serrano employment-discrimination litigation had been dismissed in September 2010, subject to the expiration of appeal rights, and the Avalos matter remained subject to an appeal. Cintas stated that potential liability for the remaining proceedings was not determinable and could be material if resolved adversely.
Key identified risks include lower sales volumes or customer losses, higher energy, labor, medical or material costs, acquisition integration risks, labor and employment-law matters, environmental liabilities, litigation, tax and regulatory changes, system or data-access disruptions, internal-control requirements and catastrophic events. Foreign-currency exposure, principally to the Canadian dollar, is partly hedged.
Most important facts for investors to verify
- Whether revenue growth in the rental business can improve without continued pressure from selling, maintenance and energy costs.
- Whether the significant decline in operating cash flow is temporary or reflects a continuing working-capital requirement.
- The sustainability of earnings benefits from the lower tax rate and the absence of the prior-year legal-settlement charge.
- The effect of recycled-paper prices on Document Management Services revenue and margins.
- Progress, costs and potential disruption associated with the enterprise-wide system conversion.
- The final outcome and potential financial exposure from the Avalos and other employment-related litigation.
- Post-quarter share repurchases, including the completion of the $1.0 billion authorization in September 2010.
- Availability and covenant compliance under the renewed revolving credit facility and the company’s ability to fund acquisitions and capital expenditures.