Cintas Corporation Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended February 28, 2017, compared with February 29, 2016. The request identifies “2016 Q3,” but the filing reports fiscal 2017 third-quarter results. Financial statements are unaudited.
Business Context
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. Reportable segments are Uniform Rental and Facility Services and First Aid and Safety Services; remaining operations are classified as All Other.
Key Financial Metrics
| Metric | Three months ended Feb. 28, 2017 | Prior comparable period | Change |
|---|---|---|---|
| Revenue | $1,281.1 million | $1,216.1 million | 5.3% |
| Operating income | $194.7 million | $193.0 million | 0.9% |
| Operating margin | 15.2% | 15.9% | Down approximately 70 bps |
| Income from continuing operations | $118.6 million | $117.3 million | 1.2% |
| Diluted EPS from continuing operations | $1.08 | $1.05 | 2.9% |
| Net income | $118.0 million | $117.3 million | 0.6% |
| Net interest expense | $13.7 million | $15.8 million | Down $2.1 million |
| Metric | Nine months ended Feb. 28, 2017 | Prior comparable period | Change |
|---|---|---|---|
| Revenue | $3,872.2 million | $3,634.1 million | 6.6% |
| Operating income | $604.5 million | $578.8 million | 4.4% |
| Income from continuing operations | $380.2 million | $338.9 million | 12.2% |
| Diluted EPS from continuing operations | $3.47 | $3.01 | 15.3% |
| Net income | $396.5 million | $562.6 million | Down 29.5% |
| Cash flow from operations | $483.8 million | $297.2 million | Up $186.6 million |
| Capital expenditures | $218.6 million | $207.5 million | Up $11.1 million |
Reported nine-month net income declined because the prior-year period included substantially larger discontinued-operation gains, principally the $349.7 million pretax gain on the Shred-it sale. Continuing operations improved materially.
Revenue, Segment Performance and Margins
- Uniform Rental and Facility Services: Third-quarter revenue rose 6.1% to $993.4 million, including 7.3% organic growth. Gross margin increased to 45.0% from 44.0%, while pretax margin declined to 17.4% from 17.9% because of higher selling and administrative costs and G&K transaction expenses.
- First Aid and Safety Services: Third-quarter revenue rose 4.4% to $124.2 million, including 5.5% organic growth. Gross margin increased to 44.8% from 42.2%, but pretax margin declined to 9.8% from 10.6% because of increased sales-force investment and less favorable workers’ compensation experience.
- Corporate and operating expenses: Third-quarter selling and administrative expenses increased 9.3% to $362.4 million. The filing cites higher labor costs, workers’ compensation costs, stock compensation, enterprise resource planning investments and sales resources for acquired customers.
- Third-quarter revenue growth was reduced by 1.7% because of one fewer workday; acquisitions contributed 0.3% and foreign currency contributed 0.2%.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents were $147.2 million at February 28, 2017, compared with $139.4 million at May 31, 2016. The company had no marketable securities at quarter-end.
- Operating cash flow of $483.8 million exceeded capital expenditures of $218.6 million. Investing cash flow was negative $165.5 million, and financing cash flow was negative $307.6 million.
- Total debt was approximately $1.145 billion, comprising $399.4 million due within one year and $745.2 million due after one year, compared with approximately $1.294 billion at May 31, 2016. Commercial paper outstanding was $99.5 million at a weighted-average rate of 1.01%.
- Cintas repaid $250.0 million of senior notes that matured June 1, 2016 and issued commercial paper to partially fund the repayment. The revolving credit facility was amended to increase capacity to $600.0 million upon the G&K acquisition and added a $250.0 million term-loan facility.
- Cintas paid $142.4 million of dividends during the nine months. It repurchased $20.1 million of common stock, primarily shares withheld for employee payroll taxes; no purchases occurred under the new $500.0 million buyback authorization as of February 28, 2017.
- Management stated that all debt covenants were satisfied. Credit ratings remained investment grade, although Moody’s reviewed the company following the announced G&K transaction and subsequently revised its ratings to P-2 commercial paper and A3 long-term debt with a stable outlook.
Material Changes and Unusual Items
- Cintas adopted ASU 2016-09 for share-based payment accounting. The adoption increased opening retained earnings by $26.7 million, reduced paid-in capital by the same amount, and provided a nine-month tax benefit of approximately $24.8 million. Management estimated that adoption increased nine-month diluted EPS by $0.17.
- G&K Services transaction expenses were $9.3 million in the quarter and $15.5 million for the nine months, reducing nine-month diluted EPS by approximately $0.10.
- The company received $25.9 million of additional Shred-it sale consideration during the nine months and recorded a related pretax gain. Additional holdback proceeds remain a gain contingency and were not recorded.
- Discontinued operations generated a $16.3 million net gain in the nine months, compared with $223.7 million in the prior-year period.
- Accumulated other comprehensive loss improved to $11.9 million at February 28, 2017 from $24.9 million at May 31, 2016, primarily due to derivative fair-value changes.
Outlook, Subsequent Events and Risks
- On March 21, 2017, after the reporting date, Cintas completed the approximately $2.2 billion acquisition of G&K Services, including acquired net debt. G&K is expected to operate within Uniform Rental and Facility Services, with combined annual revenue expected to exceed $6.0 billion and customer count expected to exceed one million.
- The acquisition was financed with $2.109 billion of new debt, including $1.7 billion of senior notes, a $250.0 million term loan and $159.0 million of commercial paper, plus cash on hand. Cintas also assumed $100.0 million of G&K senior notes.
- Interest-rate locks associated with the financing generated a deferred gain of $30.2 million; the effective portion is expected to be recorded in other comprehensive income and amortized as a reduction of interest expense beginning in the fourth quarter of fiscal 2017.
- Management provided no specific quantitative earnings or revenue guidance in the filing. The principal outlook depends on organic growth, customer retention, acquisition integration, cost synergies and post-acquisition deleveraging.
- Risks include integration and synergy execution for G&K and ZEE, higher labor, medical, energy and fuel costs, customer loss, regulatory and employment matters, foreign exchange fluctuations, environmental claims, litigation, cybersecurity and systems implementation risks, and potential adverse changes in credit ratings or borrowing costs.
- Management stated that ordinary-course litigation and claims are not expected to have a material adverse effect, although tax audits and other proceedings could affect results in a particular period.
Important Facts for Investors to Verify
- Post-acquisition leverage, debt maturities, interest expense and covenant compliance after including G&K debt and financing.
- Actual G&K revenue, margins, integration costs and realization of expected synergies.
- Whether organic revenue growth remains near the reported 6% to 7% range after adjusting for workdays, acquisitions and foreign currency.
- Operating expense trends, including labor, workers’ compensation, stock compensation, SAP/ERP implementation and sales investments.
- The sustainability of cash conversion and the company’s ability to fund capital expenditures, dividends and debt reduction.
- Final outcomes of tax audits, Shred-it holdback proceeds and other contingencies.
- Potential changes to credit ratings and resulting effects on commercial paper and long-term borrowing costs.