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 to businesses in North America. This filing covers the unaudited three months ended August 31, 2016, the first quarter of fiscal 2017, compared with the three months ended August 31, 2015.
Key Financial Metrics
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Revenue | $1,294.1 million | $1,198.9 million | +7.9% |
| Operating income | $207.0 million | $185.5 million | +11.6% |
| Operating margin | 16.0% | 15.5% | +50 basis points |
| Income from continuing operations | $138.1 million | $106.2 million | +30.0% |
| Net income | $138.1 million | $100.2 million | +37.8% |
| Diluted EPS from continuing operations | $1.26 | $0.93 | +35.5% |
| Diluted EPS | $1.26 | $0.88 | +43.2% |
| Net cash provided by operating activities | $157.6 million | $143.1 million | +10.1% |
- Revenue growth included 5.7% organic growth, a 2.3% acquisition contribution and a 0.1% unfavorable foreign-currency impact.
- Uniform Rental and Facility Services revenue increased 6.5% to $999.6 million, with a 45.9% segment gross margin and income before taxes of $185.2 million, or 18.5% of revenue.
- First Aid and Safety Services revenue increased 25.5% to $124.8 million, substantially reflecting the ZEE acquisition. Segment income before taxes increased to $11.5 million, or 9.2% of revenue.
- Capital expenditures were $78.6 million, including $66.5 million for Uniform Rental and Facility Services expansion. Cash paid for acquisitions was $11.0 million.
- Cash, cash equivalents and marketable securities totaled $163.8 million at August 31, 2016, compared with $209.8 million at May 31, 2016. Cash and cash equivalents alone were $99.2 million.
- Total debt was approximately $1.21 billion, comprising $163.8 million of commercial paper and $1.0446 billion of long-term debt, net of deferred financing fees. Commercial paper had a weighted-average interest rate of 0.74% and maturities of less than 30 days.
- The company paid $250.0 million of senior notes maturing June 1, 2016, funded with cash and commercial paper. Net interest expense declined to $14.1 million from $16.3 million.
- Net cash used in investing activities was $100.6 million, and net cash used in financing activities was $97.0 million. Cash decreased $40.1 million during the quarter.
- Cintas remained in compliance with all debt covenants and had a $450.0 million commercial-paper program supported by a revolving credit facility with an accordion feature up to $600.0 million.
Material Changes Versus the Prior Comparable Period
- Profitability improved, supported by higher sales volume, operating leverage, sourcing improvements, process efficiencies and lower energy-related expenses.
- Uniform Rental and Facility Services gross margin increased 120 basis points to 45.9%; income before taxes increased 12.0%.
- First Aid and Safety Services gross margin increased 350 basis points to 45.8%, primarily from improved sourcing and warehouse leverage following the ZEE acquisition.
- Selling and administrative expenses increased 10.5%, reflecting higher employee-related costs, SAP implementation costs and acquisition-related expenses.
- The effective tax rate on continuing operations fell to 28.4% from 37.2%. Adoption of ASU 2016-09 reduced income tax expense by $17.2 million and increased diluted share count by approximately 0.8 million shares.
- The company adopted accounting guidance requiring forfeitures of share-based awards to be recognized as incurred, increasing opening retained earnings by $26.7 million and quarterly stock-based compensation expense by $1.7 million.
- Basic weighted-average shares declined to 104.5 million from 110.6 million, reflecting prior share repurchases. A new $500.0 million repurchase authorization was approved on August 2, 2016.
- The prior-year period included a $6.0 million net loss from discontinued operations related to Shred-it and Storage; no discontinued-operation loss was recorded in the current quarter.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management did not provide explicit quarterly or full-year revenue or earnings guidance in the filing. Management expects operating cash flow, the commercial-paper program and debt-market access to fund operations, expansion and other cash requirements.
- On August 15, 2016, 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.
- The G&K transaction is expected to be financed with short- and long-term debt. A subsequent September 16, 2016 credit agreement amendment increased revolving capacity to $600.0 million and added a $250.0 million term-loan facility, with additional accordion capacity of up to $250.0 million subject to customary conditions.
- G&K closing remains subject to shareholder approval, U.S. and Canadian antitrust approvals, absence of legal restraints and satisfaction of other customary conditions. Potential risks include regulatory delays or divestitures, transaction termination, shareholder litigation, integration challenges, expected synergy realization and post-acquisition leverage.
- Moody’s placed its rating under review for possible downgrade following the announcement of the all-debt-financed G&K acquisition. The filing identifies potential effects on funding access and borrowing costs if ratings decline or are withdrawn.
- Other identified risks include lower sales volumes, customer losses, labor and material cost inflation, energy costs, foreign exchange, SAP implementation costs, cybersecurity and systems disruption, litigation, tax developments, regulatory compliance and catastrophic events.
- Management stated that ordinary-course legal proceedings and claims are not expected to have a material adverse effect, although outcomes could affect individual reporting periods.
- Interest-rate-lock liabilities had a fair value of $38.8 million at August 31, 2016, compared with $19.6 million at May 31, 2016; the change primarily affected other comprehensive income rather than current-period net income.
Important Facts for Investors to Verify
- Verify the closing status, regulatory approvals, financing and final leverage implications of the G&K Services acquisition.
- Assess whether the tax benefit from ASU 2016-09 is nonrecurring and adjust earnings comparisons accordingly.
- Monitor Moody’s review, credit ratings, commercial-paper access and compliance with debt covenants after the acquisition.
- Evaluate whether organic revenue growth and segment margin improvements are sustained without relying on acquisitions.
- Track SAP implementation costs, acquisition integration costs and the realization of expected synergies.
- Reconcile cash generation with capital expenditures, share repurchases and the anticipated debt-funded acquisition.
- Review the company’s Annual Report and merger-related filings for additional litigation, regulatory, tax and integration disclosures.