CINTAS CORP quarterly report, Q3 FY2013

Cintas Corporation — Fiscal 2013 Third-Quarter Form 10-Q

Reporting period: Three and nine months ended February 28, 2013, compared with February 29, 2012. The filing was signed April 9, 2013. Cintas provides uniform rental and sales, first aid, safety and fire protection, and document management services primarily in North America.

Financial performance

Metric	Q3 FY2013	Q3 FY2012	9M FY2013	9M FY2012
Revenue	$1.076 billion	$1.012 billion	$3.187 billion	$3.048 billion
Operating income	$133.0 million	$137.5 million	$411.3 million	$398.8 million
Net income	$74.7 million	$76.0 million	$229.5 million	$219.0 million
Diluted EPS	$0.60	$0.58	$1.83	$1.67
Operating margin	12.4%	13.6%	12.9%	13.1%
Net margin	6.9%	7.5%	7.2%	7.2%

Third-quarter revenue rose 6.3%; organic growth was 6.9%, with acquisitions contributing approximately 1.0%. Revenue was reduced by one fewer workday, estimated at 1.6%.
Third-quarter net income declined 1.7%, primarily because fixed monthly costs were spread over fewer workdays, rental material and service costs increased, and selling and administrative expenses rose.
Nine-month revenue increased 4.6%, organic growth was 4.5%, and net income increased 4.8%. Diluted EPS increased 9.6%, benefiting from share repurchases.
Net interest expense declined to $16.2 million in the quarter and $48.8 million for nine months, following repayment of $225.0 million of 6.00% notes and issuance of $250.0 million of 3.25% notes due 2022.

Segment developments

Rental Uniforms and Ancillary Products: Q3 revenue increased 3.9% to $748.9 million, but gross margin declined to 41.9% from 43.1%. Segment pretax income fell $9.9 million to $102.5 million. Nine-month revenue increased 4.5% to $2.260 billion.
Uniform Direct Sales: Q3 revenue increased 15.6% to $126.1 million, driven partly by large customer roll-outs. Gross margin declined to 29.2% because of product mix and roll-out costs.
First Aid, Safety and Fire Protection: Q3 revenue increased 11.3% to $112.9 million, including organic growth and acquisitions. Gross margin improved to 44.0%, and pretax income increased to $10.5 million.
Document Management: Q3 revenue increased 8.9% to $87.8 million and pretax income rose to $3.9 million. Nine-month revenue was essentially flat because lower recycled-paper prices offset acquisition growth; nine-month pretax income declined to $11.4 million.

Cash flow, liquidity and capital structure

Nine-month operating cash flow was $368.3 million, up from $307.7 million. Investing cash use was $254.8 million, including $151.8 million of capital expenditures and $64.6 million for acquisitions.
Financing cash use was $236.5 million, including $79.7 million of dividends and $187.1 million of common-stock repurchases, partially offset by $250.0 million of debt issuance.
Cash and cash equivalents were $217.5 million at February 28, 2013, compared with $339.8 million at May 31, 2012. Marketable securities were $28.2 million; approximately $53.7 million of cash and marketable securities was held outside the United States.
Total debt was approximately $1.309 billion, consisting primarily of fixed-rate senior notes. No commercial paper or revolving-credit borrowings were outstanding. The company had a $300.0 million commercial-paper program supported by a revolving facility expandable to $450.0 million, maturing October 6, 2016.
Cintas was in compliance with its significant debt covenants. Credit ratings were stable: S&P commercial paper A-2 and long-term debt BBB+; Moody’s commercial paper P-1 and long-term debt A2.
The company repurchased approximately 4.4 million shares for $179.4 million during the first nine months and had approximately $190.9 million remaining under its authorized buyback program at February 28, 2013.

Outlook, risks and unusual items

The filing does not provide explicit numerical revenue, earnings or margin guidance. Management’s strategy emphasizes organic growth through customer penetration, sales-force productivity, geographic expansion, acquisitions and cross-selling.
Management identified risks from operating costs, energy and fuel prices, labor and medical costs, customer outsourcing, acquisition integration, materials costs, regulation, litigation, environmental matters, information-system disruptions, foreign exchange and share repurchases.
Gross-margin pressure in the Rental segment reflected additional inventory requirements, route expansion and service costs. A $1.6 million garment-processing-system write-off affected the first nine months.
Document Management results were affected by a roughly 22% decline in average recycled-paper prices during the first nine months.
Pending employment-discrimination litigation, including the Serrano and Avalos matters, could result in material liability if resolved adversely; the company stated that any estimated liability was not determinable.
Unrecognized tax benefits declined approximately $29.9 million during the first nine months, primarily from a reclassification associated with IRS capitalization regulations. Management did not expect the finalized tangible-property regulations to have a material impact.
Disclosure controls were effective as of February 28, 2013, and no material changes to internal control over financial reporting were reported.

Investor verification points

Assess whether rental-segment gross-margin pressure and higher medical, insurance, material and route-expansion costs persist.
Verify the sustainability of organic growth after adjusting for the one fewer workday and the contribution from acquisitions.
Review acquisition performance and integration costs in First Aid, Safety and Fire Protection and Document Management.
Monitor recycled-paper prices and their effect on Document Management profitability.
Confirm debt maturities, covenant compliance, credit ratings and the availability of the revolving-credit facility.
Track remaining share-repurchase authorization, leverage and the effect of buybacks on per-share results.
Review developments and potential exposure in the Serrano/Avalos litigation and ongoing tax audits.