Cintas is an American company specialized in the manufacture and sale of workwear and uniforms
FORM 10-Q SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
OR
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12 b-2 of the Exchange Act). Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
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CINTAS CORPORATION
INDEX
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CINTAS CORPORATIONITEM 1. FINANCIAL STATEMENTS.CONSOLIDATED CONDENSED STATEMENTS OF INCOME(Unaudited)(In thousands except per share data)
See accompanying notes.
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1. Basis of Presentation
The consolidated condensed financial statements of Cintas Corporation included herein have been prepared by Cintas, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. While we believe that the disclosures are adequately presented, it is suggested that these consolidated condensed financial statements be read in conjunction with the financial statements and notes included in our most recent annual report for the fiscal year ended May 31, 2004. A summary of our significant accounting policies is presented on page 24 of our most recent annual report. There have been no material changes in the accounting policies followed by Cintas during the fiscal year.
Interim results are subject to variations and are not necessarily indicative of the results of operations for a full fiscal year. In the opinion of management, adjustments (which include only normal recurring adjustments) necessary for a fair statement of the results of the interim periods shown, have been made.
Certain prior year amounts have been reclassified to conform to current year presentation.
2. Earnings per Share
The following table represents a reconciliation of the shares used to calculate basic and diluted earnings per share for the respective years:
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3. Goodwill, Service Contracts and Other Assets
Changes in the carrying amount of goodwill for the quarter ended August 31, 2004, by operating segment, are as follows:
Information regarding Cintas’ service contracts and other assets follows:
Amortization expense was $6,729 and $6,418 for the three months ended August 31, 2004 and 2003, respectively. Estimated amortization expense, excluding any future acquisitions, for each of the next five years is $26,181, $24,372, $22,759, $20,514 and $18,127, respectively.
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4. Derivatives and Hedging Activities
Cintas formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. Cintas’ hedging activities are transacted only with highly-rated institutions, reducing the exposure to credit risk in the event of nonperformance.
Cintas uses derivatives for both cash flow hedging and fair value hedging purposes. For derivative instruments that hedge the exposure of variability in short-term interest rates, designated as cash flow hedges, the effective portion of the net gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. For the ineffective portion of the hedge, gains or losses are charged to earnings in the current period. For derivative instruments that hedge the exposure to changes in the fair value of certain fixed rate debt, designated as fair value hedges, the effective portion of the net gain or loss on the derivative instrument, as well as the offsetting gain or loss on the fixed rate debt attributable to the hedged risk, are recorded in current period earnings.
Cintas uses interest rate swap and lock agreements as hedges against variability in short-term interest rates. These agreements effectively convert a portion of the floating rate debt to a fixed rate basis, thus reducing the impact of interest rate changes on future interest expense. Cintas uses the Hypothetical Derivative Method for assessing the effectiveness of these swaps. The effectiveness of these swaps is reviewed at least every fiscal quarter. Cintas also uses reverse interest rate swap agreements to convert a portion of fixed rate debt to a floating rate basis, thus hedging for changes in the fair value of the fixed rate debt being hedged. Cintas has determined that the current interest rate swap agreements, designated as fair value hedges, qualify for treatment under the short-cut method of measuring effectiveness. Under the provisions of SFAS 133, these hedges are determined to be perfectly effective and there is no requirement to periodically evaluate effectiveness.
The change in the fair value of the cash flow hedge, pertaining to interest rate swap and lock agreements, during the first quarter of fiscal year 2005 resulted in a credit of $73 to other comprehensive income. The reverse interest rate swap agreements are fair value hedges that convert $225 million of fixed rate debt to a floating rate. These agreements expire in 2007, and allow Cintas to receive an effective interest rate of 5.13% and pay an interest rate based on LIBOR. Because these fair value hedges are 100% effective, the $700 favorable change in the fair value of these hedges were directly offset by an increase in the fair value of the debt.
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5. Stock-Based Compensation
During the third quarter of fiscal 2003, Cintas adopted the disclosure requirements of FASB Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, but will continue to apply Accounting Principles Board Opinion No. 25 as the method used to account for stock-based employee compensation arrangements. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period.
6. Comprehensive Income
Total comprehensive income represents the net change in shareholders’ equity during a period from sources other than transactions with shareholders and, as such, includes net earnings. For Cintas, the only other components of total comprehensive income are the change in cumulative foreign currency translation adjustments and the change in the fair value of forecasted cash flows associated with a derivative accounted for as a cash flow hedge. The components of comprehensive income for the three month periods ended August 31, 2004 and 2003 are as follows:
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7. Segment Information
Cintas classifies its businesses into two operating segments: Rentals and Other Services. The Rentals operating segment designs and manufactures corporate identity uniforms which it rents, along with other items, to its customers. The Other Services operating segment involves the design, manufacture and direct sale of uniforms to its customers, as well as the sale of ancillary products and services. These ancillary products and services include restroom supplies, first aid and safety products and services, document management services and cleanroom supplies. All of these services are provided throughout the United States and Canada to businesses of all types — from small service and manufacturing companies to major corporations that employ thousands of people.
The $4,343 write-off of the loan receivable in the first quarter of fiscal 2004 has been included in the Corporate segment.
Information as to the operations of Cintas’ different business segments is set forth below based on the distribution of products and services offered. Cintas evaluates performances based on several factors of which the primary financial measures are business segment revenue and income before income taxes.
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8. Supplemental Guarantor Information
Effective June 1, 2000, Cintas reorganized its legal structure and created Cintas Corporation No. 2 (Corp. 2) as its indirectly, wholly-owned principal operating subsidiary. Cintas and its wholly-owned, direct and indirect domestic subsidiaries, other than Corp. 2, unconditionally guaranteed, jointly and severally, debt of Corp. 2.
On May 13, 2002, Cintas completed the acquisition of Omni Services, Inc. (Omni) for $656,071. The purchase price for Omni was funded with $450,000 in long-term notes, $100,000 of borrowings under a commercial paper program and $106,071 in cash. The $450,000 in long-term notes consists of $225,000 with five-year maturities at an interest rate of 5.125% and $225,000 with ten-year maturities at an interest rate of 6%. An additional working capital payment of $3,055 was made during the second quarter of fiscal 2003, bringing the total purchase price to $659,126. Corp. 2 was the issuer of the $450,000 long-term notes, which are unconditionally guaranteed, jointly and severally, by Cintas Corporation and the subsidiary guarantors.
As allowed by SEC rules, the following condensed consolidating financial statements are provided as an alternative to filing separate financial statements of the guarantors. Each of the subsidiaries presented in the condensed financial statements has been fully consolidated in Cintas’ financial statements. The condensed consolidating financial statements should be read in conjunction with the financial statements of Cintas and notes thereto of which this note is an integral part.
Condensed consolidating financial statements for Cintas, Corp. 2, the subsidiary guarantors and non-guarantors are presented below:
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CONDENSED CONSOLIDATED INCOME STATEMENTTHREE MONTHS ENDED AUGUST 31, 2003
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWSTHREE MONTHS ENDED AUGUST 31, 2003
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Revenue, Expenses and Income
Revenue Comparison
Total revenue increased 10% for the three months ended August 31, 2004, over the same period in fiscal 2004. After a few years of operating in a difficult economic environment, we have begun to experience some improved economic activity with our customers. Our organic growth rate has now strengthened each of the last four fiscal quarters.
Rentals operating segment revenues consist predominantly of revenues derived from the rental of corporate identity uniforms, mats, shop towels and other items. Net Rentals revenue increased 8% for the three months ended August 31, 2004, over the same period in the prior fiscal year. Rentals operating segment internal growth for the first quarter of fiscal 2005, when adjusted for the additional workday for the three months ended August 31, 2004, was 6% as compared to the three months ended August 31, 2003. This increase is primarily due to the sale of new rental programs to new customers as well as the continued penetration of ancillary products into our existing customer base. Rentals revenue growth was negatively impacted by lost business.
Other Services operating segment revenues are derived from the design, manufacture and direct sale of uniforms to our customers, as well as ancillary services including restroom and cleanroom supplies, first aid and safety products and services and document management services. Other Services Revenue increased 18% for the three months ended August 31, 2004, over the same period in the prior year. This increase was due to a combination of acquisitions of first aid and safety service and document management businesses as well as increased sales of first aid and safety products and services to new customers. Increased product penetration into our first aid and safety customer base also contributed to this increase. Other Services operating segment internal growth for the first quarter of fiscal 2005, when adjusted for the additional workday for the three months ended August 31, 2004, was 5% as compared to the three months ended August 31, 2003.
Expense Comparison
Cost of rentals consists primarily of production expenses, delivery expenses and amortization of in service uniforms and other rental items. Cost of rentals increased 7% for the three months ended August 31, 2004, as compared to the three months ended August 31, 2003, as a result of increased Rentals revenues and increased energy and labor-related costs.
Cost of other services consists primarily of cost of goods sold (predominantly uniforms and first aid products), delivery expenses and distribution expenses. Cost of other services increased 19% for the three months ended August 31, 2004, as compared to the three months ended August 31, 2003. Product sales mix also contributed slightly to this increase.
Selling and administrative expenses increased 13% for the three months ended August 31, 2004, as compared to the three months ended August 31, 2003. Selling and administrative expenses increased mainly due to increased revenues, sales force additions and marketing and sales promotions. Costs of providing medical benefits to our employees also increased, accounting for a portion of the rise in administrative expenses.
We anticipate a continued rise in energy and labor-related costs.
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Net interest expense (interest expense less interest income) was $5 million for the three months ended August 31, 2004, compared to $6 million for the same period in the prior fiscal year. This decrease was primarily a result of lower outstanding debt levels as compared to the prior year.
Cintas’ effective tax rate was 37.0% for both the three months ended August 31, 2004 and August 31, 2003.
Included in net income for the first quarter of fiscal 2004 was a pre-tax charge of $4.3 million from a write-off of a receivable from a garment manufacturer. Based on concerns on the supplier’s viability to remain as a going concern, the receivable was completely written off.
Income Comparison
Net income increased 15% for the three months ended August 31, 2004, over the same period in fiscal 2004, primarily due to increased efficiencies from revenue growth and cost containment initiatives. Diluted earnings per share increased 14% for the three months ended August 31, 2004, over the same period in the prior fiscal year.
Financial Condition
At August 31, 2004, there was $264 million in cash, cash equivalents and marketable securities, an increase of $10 million from May 31, 2004, primarily due to additional cash generation from increased revenues. Capital expenditures were $35 million for the quarter ended August 31, 2004, and we expect capital expenditures for the year to be between $140 and $160 million. Cash, cash equivalents and marketable securities will be used to finance future growth, capital expenditures, repayment of debt and dividends. Cintas also has additional borrowing capacity for use in future acquisitions. We believe that our current cash position, funds generated from operations and the strength of our banking relationships are sufficient to meet our anticipated operational and capital requirements.
Net property and equipment increased by $5 million from May 31, 2004 to August 31, 2004 due to continued investment in rental facilities and equipment. At the end of the first quarter of fiscal 2005, Cintas had four uniform rental facilities in various stages of construction.
Following is information regarding Cintas’ long-term contractual obligations and other commitments outstanding as of August 31, 2004:
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Litigation and Other Contingencies
Cintas is subject to legal proceedings and claims arising from the ordinary course of its business, including personal injury, customer contract, environmental and employment claims. In the opinion of management, the aggregate liability, if any, with respect to such ordinary course of business actions, will not have a material adverse effect on the financial position or results of operations of Cintas. Cintas is party to additional litigation not considered in the ordinary course of business, including the litigation discussed below.
Cintas is a defendant in a purported class action lawsuit, Paul Veliz, et al., v. CintasCorporation, filed on March 19, 2003, in the United States District Court, Northern District of California, Oakland Division, alleging that Cintas violated certain federal and state wage and hour laws applicable to its service sales representatives, whom Cintas considers exempt employees, and asserting additional related ERISA claims. The plaintiffs are seeking unspecified monetary damages, injunctive relief, or both. Cintas denies these claims and is defending the plaintiffs’ allegations. The court ordered arbitration for all potential plaintiffs except for those that fall into one of four narrowly defined exceptions. As a result, Cintas believes that a majority of the potential plaintiffs will be required to arbitrate their claims. No determination has been made by the court or an arbitrator regarding class certification. There can be no assurance as to whether a class will be certified or, if a class is certified, as to the geographic or other scope of such class. If a court or arbitrator certifies a class in this action and there is an adverse verdict on the merits, or in the event of a negotiated settlement of the action, the resulting liability and/or any increased costs of operations on an ongoing basis could be material to Cintas. Any estimated liability relating to this lawsuit is not determinable at this time.
Cintas is also a defendant in a purported class action lawsuit, Robert Ramirez, et al., v.Cintas Corporation, filed on January 20, 2004, and pending in the United States District Court, Northern District of California, San Francisco Division. The case was brought on behalf of all past and present female, African-American and Hispanic employees of Cintas and its subsidiaries. The complaint alleges that Cintas has engaged in a pattern and practice of discriminating against women and minorities in recruitment, hiring, promotions, transfers, job assignments and pay. The complaint seeks injunctive relief, compensatory damages, punitive damages and attorney’s fees, among other things. Cintas denies these claims and is defending the plaintiffs’ allegations. No filings or determination has been made as to class certification. There can be no assurance as to whether a class will be certified or, if a class is certified, as to the geographic or other scope of such class. If a court certifies a class in this action and there is an adverse verdict on the merits, or in the event of a negotiated settlement of the action, the resulting liability and/or any increased costs of operations on
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an ongoing basis could be material to Cintas. Any estimated liability relating to this lawsuit is not determinable at this time.
The litigation discussed above, if decided adversely to or settled by Cintas, may, individually or in the aggregate, result in liability material to Cintas’ financial condition or results of operations. Cintas may enter into discussions regarding settlement of these and other lawsuits, and may enter into settlement agreements if it believes such settlement is in the best interests of Cintas’ shareholders.
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
In our normal operations, Cintas has market risk exposure to interest rates. There has been no significant change in our exposure to these risks, which has been previously disclosed on page 47 of our most recent annual report.
ITEM 4.
CONTROLS AND PROCEDURES.
An evaluation was completed under the supervision and with the participation of Cintas’ management, including Cintas’ President and Chief Executive Officer, Chief Financial Officer, General Counsel and Controllers, of the effectiveness of the design and operation of Cintas’ disclosure controls and procedures as of August 31, 2004. Based on these evaluations, Cintas’ management, including the President and Chief Executive Officer, Chief Financial Officer, General Counsel and Controllers, concluded that Cintas’ disclosure controls and procedures were effective as of August 31, 2004. There has been no change to Cintas’ internal control over financial reporting that occurred during the first quarter of fiscal 2005 that has materially affected, or is reasonably likely to materially affect, Cintas’ internal control over financial reporting.
Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a safe harbor from civil litigation for forward-looking statements. Forward-looking statements may be identified by words such as estimates, anticipates, projects, plans, expects, intends, believes, should and similar expressions and by the context in which they are used. Such statements are based upon current expectations of Cintas and speak only as of the date made. These statements are subject to various risks, uncertainties and other factors that could cause actual results to differ from those set forth in this report. Factors that might cause such a difference include the possibility of greater than anticipated operating costs, lower sales volumes, the performance and costs of integration of acquisitions, fluctuations in costs of materials and labor, costs and possible effects of union organizing activities, outcome of pending environmental matters, the initiation or outcome of litigation, higher assumed sourcing or distribution costs of products and the reactions of competitors in terms of price and service. Cintas undertakes no obligation to update any forward-looking statements to reflect the events or circumstances arising after the date on which they are made.
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Part II. Other Information
Item 6. Exhibits
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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