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 a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12 b-2 of the Exchange Act). Large Accelerated Filer [X} Accelerated Filer [ ] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell copany (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
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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CINTAS CORPORATIONCONSOLIDATED CONDENSED BALANCE SHEETS(In thousands except share data)
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CINTAS CORPORATIONCONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS(Unaudited)(In thousands)
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CINTAS CORPORATIONNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Unaudited)(Amounts in thousands except per share data)
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 consolidated financial statements and notes included in our most recent annual report for the fiscal year ended May 31, 2005. A summary of our significant accounting policies is presented on page 30 of that 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. This is especially true in the second and third quarters of fiscal 2006 given the effects of weather events and the significant increase in fuel costs. In the opinion of management, adjustments (which include only normal recurring adjustments) necessary for a fair statement of the consolidated results of the interim periods shown have been made.
Certain prior year amounts have been reclassified to conform to current year presentation.
2. New Accounting Standard
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No. 123 (revised 2004), Share-Based Payment, (Statement 123R), which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Generally, the approach in Statement 123R is similar to the approach described in Statement 123. However, Statement 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of income based on their fair values. Pro forma disclosure is no longer an alternative. The new standard will be effective for public entities (excluding small business issuers) no later than the beginning of the first fiscal year beginning after June 15, 2005. Cintas will adopt this Statement on June 1, 2006. Cintas is in the process of determining the impact that the adoption of Statement 123R will have on its consolidated financial position and results of operations.
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CINTAS CORPORATIONNOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Unaudited)(In thousands except per share data)
3. Earnings per Share
The following table represents a reconciliation of the shares used to calculate basic and diluted earnings per share for the respective periods:
4. Goodwill, Service Contracts and Other Assets
Changes in the carrying amount of goodwill and service contracts for the nine months ended February 28, 2006, by operating segment, are as follows:
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Information regarding Cintas’ service contracts and other assets follows:
Amortization expense was $24,130 and $20,726 for the nine months ended February 28, 2006 and February 28, 2005, respectively. Estimated amortization expense, excluding any future acquisitions, for each of the next five years is $33,743, $37,565, $34,768, $32,223 and $29,073, respectively.
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5. Debt, 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.
From time to time, Cintas will use 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.
From time to time, 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 measuring the effectiveness of these swaps. There are no interest rate swap agreements outstanding as of February 28, 2006. When outstanding, 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. These agreements involve the receipt of fixed rate amounts in exchange for floating rate interest payments over the life of the agreements without an exchange of underlying principal amount. The mark-to-market values of both the fair value hedging instruments and the underlying debt obligations are equal and recorded as offsetting gains and losses in current period earnings. Cintas has determined that the current reverse interest rate swap agreements, designated as fair value hedges, qualify for treatment under the short-cut method of measuring effectiveness. Under the provisions of Statement 133, these hedges are determined to be perfectly effective and there is no requirement to periodically evaluate effectiveness. Cintas terminated its reverse interest rate swap agreements on September 1, 2005, thereby converting $225,000 in long-term debt back to fixed rate debt with an effective interest rate of 5.13%.
Cintas entered into two interest rate lock agreements as part of the Omni acquisition in fiscal 2002. The amortization of the cash flow hedge, pertaining to these lock agreements, resulted in a credit to other comprehensive income of $72 for the three months ended February 28, 2006, and $218 for the nine months ended February 28, 2006.
During the third quarter of fiscal 2006, Cintas entered into a cash settled forward starting swap to protect forecasted interest payments from interest rate movement for an anticipated $200,000 debt issuance in 2007. The Hypothetical Derivative Method will be used to measure hedge effectiveness. Cintas expects that the forward starting swap will be perfectly effective as the critical terms of the anticipated debt issuance will perfectly offset the hedged cash flows of the forecasted interest payments. Over the next eighteen months, if the 30-year Treasury rate increases, the bank will make a payment to Cintas. Conversely, if the 30-year Treasury rate decreases, Cintas will pay the bank. These payments will increase or decrease cash with an offset to other comprehensive income in shareholders’ equity and will be amortized to earnings over the term of the debt issuance in 2007.
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Cintas has certain significant covenants related to debt agreements. These covenants limit Cintas’ ability to incur certain liens, to engage in sale-leaseback transactions and to merge, consolidate or sell all or substantially all of Cintas’ assets. These covenants also require Cintas to maintain certain debt to capitalization and interest coverage ratios. Cross default provisions exist between certain debt instruments. Cintas is in compliance with all of the significant debt covenants for all periods presented. Were a default of a significant covenant to occur, the default could result in an acceleration of indebtedness, impair liquidity and limit the ability to raise future capital. Cintas’ debt, net of cash and marketable securities, is $387,676. For the nine months ended February 28, 2006, net cash provided by operating activities was $311,319. Capital expenditures were approximately $102,080 for the same period.
6. Stock-Based Compensation
Cintas follows the disclosure requirements of FASB Statement No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, but continues to apply Accounting Principles Board Opinion No. 25 as the method used to account for stock-based employee compensation arrangements. See Note 2 entitled New Accounting Standard regarding a new accounting standard for share-based payments, which Cintas will adopt on June 1, 2006. 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:
During fiscal 2005, the Compensation Committee of the Board of Directors approved a resolution to accelerate the vesting for certain “out-of-the-money” options. The options which were accelerated were provided to employees during fiscal 2000, 2001, 2002 and 2003. The Compensation Committee approved this acceleration in order to provide these employees the increased benefit of exercising these options when they become in-the-money and to avoid recognizing future compensation expense related to outstanding options under SFAS No. 123(R). After amendment of all underlying option agreements, compensation expense to be recognized in the statement of income during the first year of adoption of SFAS No. 123(R) was reduced by approximately $3,500.
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7. 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 components of total comprehensive income are the change in cumulative foreign currency translation adjustments and the change in the fair value of the forecasted cash flows associated with a derivative accounted for as a cash flow hedge. The components of comprehensive income for the three and nine month periods ended February 28, 2006 and February 28, 2005 are as follows:
8. Segment Information
Cintas classifies its businesses into two operating segments, Rentals and Other Services, based on the similar economic characteristics of the products and services within each segment. The Rentals operating segment reflects the rental and servicing of uniforms and other garments, mats, mops and shop towels. In addition to these rental items, we also provide restroom and hygiene products and services within this segment. The Other Services operating segment consists of the direct sale of uniforms and related items, first aid, safety and fire protection products and services, document management services and branded promotional products. Both segments provide these products and services 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.
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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9. 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. On August 23, 2005, an amended complaint was filed alleging additional state law wage and hour claims under the following state laws: Arkansas, Kansas, Kentucky, Maine, Maryland, Massachusetts, Minnesota, New Mexico, Ohio, Oregon, Pennsylvania, Rhode Island, Washington, West Virginia and Wisconsin. The plaintiffs are seeking unspecified monetary damages, injunctive relief or both. Cintas denies these claims and is defending the plaintiffs’ allegations. On February 14, 2006, the Court ordered a majority of the opt-in plaintiffs to arbitrate their claims in accordance with the terms of their Cintas employment agreement. 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.
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CINTAS CORPORATION NOTESTO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Unaudited)(In thousands except per share data)
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 applicants and 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. The court has ordered four of the named plaintiffs to arbitrate their claims. On April 27, 2005, the United States Equal Employment Opportunity Commission (EEOC) intervened in order to participate in this lawsuit. No filings or determination has been made in regard to the lawsuit 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. Several related proceedings with similar allegations and seeking similar relief damages and fees are pending, including a class action lawsuit,Mirna E. Serrano, et al., v. Cintas Corporation, filed on May 10, 2004, in the United States District Court for the Eastern District of Michigan, Southern Division on behalf of female service sales representative job applicants at all Cintas locations in Michigan. On September 6, 2005, a Magistrate Judge granted Plaintiffs’ motion for leave to file a second amended complaint to expand the lawsuit to a nationwide claim. On November 15, 2005, the EEOC intervened in Serrano to participate in the lawsuit in continuation of an EEOC charge filed on April 17, 2000, by Mirna Serrano with the EEOC Detroit District office. On February 24, 2006, a motion to intervene in Serrano was filed by intervening Plaintiffs Colleen Grindle, et al., on behalf of a nationwide subclass and an Ohio subclass of female employees in Cintas’ Rental Division who were allegedly denied hire, promotion or transfer to a SSR position. On July 15, 2005, the EEOC terminated the processing of an administrative action filed on December 15, 2004, by James Morgan with the EEOC Washington, D.C. office and the California Department of Fair Employment and Housing alleging racial discrimination in compensation and training opportunities and issued a right to sue letter. On August 3, 2005, Morgan joined the Ramirez lawsuit. On November 2, 2005, the Court entered an order requiring Morgan to arbitrate all of his claims for monetary damages. In addition, a class action lawsuit, Larry Houston, et al., v. Cintas Corporation, was filed on August 3, 2005, in the United States District Court for the Northern District of California on behalf of African-American managers alleging racial discrimination. On November 22, 2005, the Court entered an order requiring the named plaintiffs in the Houston lawsuit to arbitrate all of their claims for monetary damages. If there is an adverse verdict or a negotiated settlement of these actions, the resulting liability and/or any increased costs of operations on an ongoing basis could be material to Cintas. Any estimated liability relating to these proceedings is not determinable at this time.
Several other similar administrative proceedings are pending including: (i) two charges filed on November 30, 2004, by an EEOC Commissioner with the EEOC Systemic Litigation Unit alleging failure to hire and assign females to production job positions, and failing to hire females, African-Americans and Hispanics into the Management Trainee program, (ii) a charge filed on January 24, 2005, by Jennifer Fargo on behalf of herself and a similarly situated class with the Augusta Human Relations Commission and the EEOC Detroit District office alleging gender and equal pay discrimination against female sales representatives and sales associates, (iii) a charge filed on March 23, 2005, by Clifton Cooper on behalf of himself and a similarly situated class with the EEOC Systemic Litigation Unit alleging discriminatory pay and treatment due to race, (iv) a charge filed on April 25, 2005, by Melissa Schulz on behalf of herself and a similarly situated class with the EEOC Systemic Litigation Unit and the Oregon Bureau of Labor and Industries, Civil Rights Division alleging discriminatory pay and treatment due to race and gender and (v) a charge filed on June 10, 2005, by Mattie Cooper on behalf of herself and a similarly situated class with the EEOC Systemic Litigation Unit alleging discriminatory pay and treatment due to race and gender. The investigations of these allegations are pending and no determinations have been made. On November 2, 2005, the EEOC issued a dismissal and notice of rights letter and closed its file on the Lorelei Reynolds charge filed on March 28, 2005, with the EEOC Birmingham District office alleging discriminatory pay and treatment due to race and gender on behalf of herself and a similarly situated class.
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Cintas is also a defendant in a lawsuit, J. Lester Alexander, III vs.Cintas Corp., et al., which was originally filed on October 25, 2004, and is currently pending in the United States Bankruptcy Court for the Middle District of Alabama, Eastern Division. The case was brought by J. Lester Alexander, III, the Chapter 7 Trustee (the “Trustee”) of Terry Manufacturing Company, Inc. (“TMC”) and Terry Uniform Company, LLC (“TUC”), against Cintas in Randolph County, Alabama. The Trustee seeks damages against Cintas for allegedly breaching fiduciary duties to TMC and TUC and for allegedly aiding and abetting breaches of fiduciary duties by others to those entities. The complaint also includes allegations that Cintas breached certain limited liability company agreements, or alternatively, misrepresented its intention to perform its obligations in those agreements and acted as alter egos of the bankrupt TMC and is therefore liable for all of TMC’s debts. The Trustee is seeking $50,000 in compensatory damages and $100,000 in punitive damages. Cintas denies these claims and is vigorously defending itself against all claims in the complaint. If there is an adverse verdict on the merits or in the event of a negotiated settlement of this lawsuit, the resulting liability 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.
10. 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). A portion of the purchase price for Omni was funded with $450,000 in long-term notes. Corp. 2 was the issuer of the 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 consolidating 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 CONSOLIDATING INCOME STATEMENTTHREE MONTHS ENDED FEBRUARY 28, 2006
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CONDENSED CONSOLIDATING INCOME STATEMENTTHREE MONTHS ENDED FEBRUARY 28, 2005
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CONDENSED CONSOLIDATING INCOME STATEMENTNINE MONTHS ENDED FEBRUARY 28, 2006
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CONDENSED CONSOLIDATED INCOME STATEMENTNINE MONTHS ENDED FEBRUARY 28, 2005
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CONDENSED CONSOLIDATING BALANCE SHEETAS OF FEBRUARY 28, 2006
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CONDENSED CONSOLIDATING BALANCE SHEETAS OF MAY 31, 2005
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSNINE MONTHS ENDED FEBRUARY 28, 2006
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CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSNINE MONTHS ENDED FEBRUARY 28, 2005
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CINTAS CORPORATIONITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
We are North America’s leading provider of corporate identity uniforms through rental and sales programs, as well as a significant provider of related business services, including entrance mats, restroom products and services, restroom cleaning services, first aid, safety and fire protection products and services, document management services and cleanroom services. Our products and services are designed to enhance our customers’ images and to provide additional safety and protection in the workplace.
Our business strategy is to increase our market share of the uniform rental and sales business in North America through the sale of new uniform programs and to provide our customers with all of the products and services we offer. We will also continue to identify additional product and service opportunities to provide to our current and future customers. Our long-term goal is to provide a product or service to every business in North America.
To pursue this strategy, we focus on the development of a highly talented and diverse team of employees (who we call partners) – a team that is properly trained and motivated to service our customers. We support our partners’ service efforts by providing superior products with distinct competitive advantages and we embrace technological advances.
Continuous cost containment and product and process innovation are considered hallmarks of our organization. In order to sustain these efforts, we implemented a Six Sigma effort within Cintas. Six Sigma is an analytical process that assists companies in improving quality and customer satisfaction while reducing cycle time and operating costs. We are pleased with our progress in this endeavor and are optimistic about the improved efficiencies that this process will continue to yield to Cintas.
We continue to leverage our size and core competencies to become a more valued business service provider to our current and future customers. We will also continue to supplement our internal growth with strategic acquisitions and through the cultivation of new businesses.
Cintas classifies its businesses into two operating segments, Rentals and Other Services, based on the similar economic characteristics of the products and services within each segment. The Rentals operating segment reflects the rental and servicing of uniforms and other garments, mats, mops and shop towels. In addition to these rental items, we also provide our restroom and hygiene products and services within this segment. The Other Services operating segment consists of the direct sale of uniforms and related items, first aid, safety and fire protection products and services, document management services and branded promotional products. Both segments provide these products and services 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.
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Revenue, Expenses and Income
Revenue Comparison
Total revenue increased 10.7% for the three months ended February 28, 2006, over the same period in fiscal 2005. Internal growth for this period was 7.7%. The remaining 3.0% represents growth derived mainly through the acquisitions of uniform and mat rental businesses in our Rentals segment and acquisitions of first aid, safety and fire protection businesses and document management businesses within our Other Services segment.
Net Rentals revenue increased 8.4% for the three months ended February 28, 2006, over the same period in the prior fiscal year. Rentals operating segment internal growth for the third quarter of fiscal 2006 was 7.5% as compared to the three months ended February 28, 2005, when adjusted for the impact of the hurricanes. This increase is primarily due to the sale of new rental programs to customers, offset by lost business. The remaining growth was generated primarily through the acquisition of uniform and mat rental businesses.
Other Services revenue increased 18.8% for the three months ended February 28, 2006, over the same period in the prior year. Other Services operating segment internal growth for the third quarter of fiscal 2006 was 9.5% as compared to the three months ended February 28, 2005, when adjusted for the impact of the hurricanes. This internal growth was generated primarily through the increased direct sale of uniforms to national customers and increased sales of first aid and safety products and services and document management services to customers. The additional growth was generated through a combination of acquisitions of first aid, safety and fire protection businesses and document management businesses.
Expense Comparison
Cost of rentals consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other rental items. Cost of rentals increased 9.3% for the three months ended February 28, 2006, as compared to the three months ended February 28, 2005. This increase reflects the growth in Rentals revenue and a 40% increase in Rentals energy costs, offset by various operational efficiencies. Rentals energy costs were approximately $28 million for the three months ended February 28, 2006, versus approximately $20 million for the same period in the prior year. Cost of rentals increased as a percent to Rentals revenue to 55.5% for the three months ended February 28, 2006, as compared to 55.0% for the three months ended February 28, 2005. This 0.5% increase reflects a Rentals energy charge increase of 1.0% of Rentals revenue, offset by various operational efficiencies.
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 17.5% for the three months ended February 28, 2006, as compared to the three months ended February 28, 2005. This increase was mainly due to increased sales in this segment. Gross margin within this segment may fluctuate depending on the type of product or service sold, as more cost efficient sourcing is employed and as products which require additional services or specialization generate higher gross margins. For example, tailored garments that incorporate high levels of design and customization tend to generate higher gross margins than work wear and standard catalog items. Generally, the gross margin for Other Services is in the 30% to 35% range. The current quarter’s gross margin is 35.3%, which is slightly above that general range, mainly due to product mix.
Selling and administrative expenses increased 9.5% for the three months ended February 28, 2006, as compared to the three months ended February 28, 2005. Selling and administrative expenses as a percent of revenue decreased 0.3% for the three months ended February 28, 2006, as compared to the three months ended February 28, 2005. This decrease on a percent to revenue basis reflects the improved leverage
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of higher sales in both Rentals and Other Services. In order to accelerate revenue growth, we continue to increase our sales force, marketing plans and sales promotions. These measures combined to increase our selling costs by approximately $5 million over the prior year. In addition, administrative expenses increased by approximately $3 million as a result of increases in medical and retirement benefits.
We expect recent increases in fuel costs to continue to negatively impact our operating results in coming quarters, except to the extent we are able to offset such costs with price increases and increased operating efficiencies. Our Gulf Coast operations continue to be negatively impacted by the hurricanes Katrina, Rita and Wilma. While physical damage to our facilities is minimal, many of our customers in the region have yet to reopen or to return to pre-hurricane staffing levels. This lower business volume will continue to have an impact on our results. We are actively pursuing settlement of our losses related to these hurricanes with our insurance carrier. We do not yet have a clear indication of when a settlement agreement will be resolved, nor can we be sure of the amount, if any, we will receive.
Net interest expense (interest expense less interest income) was $5.3 million for the three months ended February 28, 2006, compared to $4.4 million for the same period in the prior fiscal year. This increase in net interest expense is primarily due to increased interest rates on our outstanding debt and the increased level of borrowing used to fund the stock repurchase program.
Cintas’ effective tax rate increased to 37.5% for the three months ended February 28, 2006, as compared to 37.0% for the three months ended February 28, 2005, due to changes in state tax laws. Our fiscal year to date effective tax rate is 37.3%.
Income Comparison
Net income increased 9.0% for the three months ended February 28, 2006, over the same period in fiscal 2005, primarily due to revenue growth. Diluted earnings per share increased 12.2% for the three months ended February 28, 2006, over the same period in the prior fiscal year.
Total revenue increased 10.5% for the nine months ended February 28, 2006, over the same period in fiscal 2005. Internal growth for this period was 8.1%. The remaining 2.4% represents growth derived mainly through the acquisitions of uniform and mat rental businesses in our Rentals segment and acquisitions of first aid, safety and fire protection businesses and document management businesses within our Other Services segment.
Net Rentals revenue increased 8.2% for the nine months ended February 28, 2006, over the same period in the prior fiscal year. Rentals operating segment internal growth through the third quarter of fiscal 2006 was 7.8% as compared to the nine months ended February 28, 2005, when adjusted for the impact of the hurricanes. This increase is primarily due to the sale of new rental programs to customers, offset by lost business. The remaining growth was generated primarily through the acquisition of uniform and mat rental businesses.
Other Services revenue increased 18.6% for the nine months ended February 28, 2006, over the same period in the prior year. Other Services operating segment internal growth through the third quarter of fiscal 2006 was 10.6% as compared to the nine months ended February 28, 2005, when adjusted for the impact of the hurricanes. This internal growth was generated primarily through the increased direct sale of uniforms to national customers and increased sales of first aid and safety products and services and document management services to customers. The additional growth was generated through a combination of acquisitions of first aid, safety and fire protection businesses and document management businesses.
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Cost of rentals consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other rental items. Cost of rentals increased 8.1% for the nine months ended February 28, 2006, as compared to the nine months ended February 28, 2005. This increase reflects the growth in Rentals revenue and a 34% increase in Rentals energy costs, offset by various operational efficiencies. Rentals energy costs were approximately $74.7 million for the nine months ended February 28, 2006, versus approximately $55.8 million for the same period in the prior year. Cost of rentals as a percent to Rentals revenue was 55.0% for both the nine months ended February 28, 2006 and 2005. The cost of rentals as a percent to Rentals revenue for the nine months ended February 28, 2006 reflects a Rentals energy charge increase of 1.0% of Rentals revenue compared to the nine months ended February 28, 2005.
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 16.8% for the nine months ended February 28, 2006, as compared to the nine months ended February 28, 2005. This increase was mainly due to increased sales in this segment. Gross margin within this segment may fluctuate depending on the type of product or service sold, as more cost efficient sourcing is employed and as products which require additional services or specialization generate higher gross margins. For example, tailored garments that incorporate high levels of design and customization tend to generate higher gross margins than work wear and standard catalog items. Generally, the gross margin for Other Services is in the 30% to 35% range. The current year to date gross margin is 34.4%, which is at the upper end of that general range, mainly due to product mix.
Selling and administrative expenses increased 11.6% for the nine months ended February 28, 2006, as compared to the nine months ended February 28, 2005. Selling and administrative expenses increased primarily due to higher selling expenses. In order to accelerate revenue growth, we continue to increase our sales force, marketing plans and sales promotions. These measures combined to increase our selling costs by approximately $17 million over the prior year. The cost of providing medical and retirement benefits to our employees increased $12.7 million, representing a 14.4% increase over the prior year. In addition, administrative expenses increased by $3.9 million as a result of an increase in the bad debt reserve and by $4.6 million as a result of an increase in professional services relating to the outsourcing of certain human resource functions.
Recent increases in fuel costs will continue to negatively impact our operating results in coming quarters, except to the extent we are able to offset such costs with price increases and increased operating efficiencies. Our Gulf Coast operations continue to be negatively impacted by the hurricanes Katrina, Rita and Wilma. While physical damage to our facilities is minimal, many of our customers in the region have yet to reopen or to return to pre-hurricane staffing levels. This lower business volume will continue to have an impact on our results. We are actively pursuing settlement of our losses related to these hurricanes with our insurance carrier. We do not yet have a clear indication of when a settlement agreement will be resolved, nor can we be sure of the amount, if any, we will receive.
Net interest expense (interest expense less interest income) was $17.1 million for the nine months ended February 28, 2006, compared to $13.8 million for the same period in the prior fiscal year. This increase in net interest expense is due to increased interest rates on our outstanding debt and the increased level of borrowing used to fund the stock repurchase program.
Cintas’ effective tax rate increased to 37.3% for the nine months ended February 28, 2006, as compared to 37.0% for the nine months ended February 28, 2005, due to changes in state tax laws.
Net income increased 8.1% for the nine months ended February 28, 2006, over the same period in fiscal 2005, primarily due to revenue growth. Diluted earnings per share increased 10.3% for the nine months ended February 28, 2006, over the same period in the prior fiscal year.
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Financial Condition
At February 28, 2006, there was $251 million in cash, cash equivalents and marketable securities, a decrease of $59 million from May 31, 2005. This decrease was primarily due to funding the shareholder dividend, recent acquisitions and the repurchasing of our company stock, as discussed below. Capital expenditures were approximately $102 million for the nine months ended February 28, 2006. We expect capital expenditures for the year to be between $130 and $140 million. Cash, cash equivalents and marketable securities will be used to finance future acquisitions, capital expenditures, expansion and additional repurchases under the stock repurchase program as detailed below. 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 $32 million from May 31, 2005 to February 28, 2006, due to our continued investment in rental facilities and equipment. At the end of the third quarter of fiscal 2006, Cintas had two uniform rental facilities under construction.
During fiscal 2006, Cintas has executed its $500 million stock repurchase program that the Board of Directors authorized and announced in May 2005. No shares were repurchased in the three months ended February 28, 2006. For the nine months ended February 28, 2006, Cintas purchased approximately 2.9 million shares of Cintas stock at an average price of $39.48 per share for a total purchase price of approximately $114 million. From the inception of the stock repurchase program through March 31, 2006, Cintas has purchased approximately 4.4 million shares of Cintas stock at an average price of $39.53 per share for a total purchase price of approximately $172 million. The Board did not specify an expiration date for this program.
Following is information regarding Cintas’ long-term contractual obligations and other commitments outstanding as of February 28, 2006:
Cintas also makes payments to defined contribution plans. The amounts of contributions made to the plans are made at the discretion of Cintas. Future contributions are assumed to increase 15% annually. Assuming this 15% increase, payments due in one year or less would be $29,092, two to three years would be $71,929 and four to five years would be $95,126. Payments for years thereafter are assumed to continue increasing by 15% each year.
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Cintas has no off-balance sheet arrangements other than the synthetic leases on two corporate jets. The synthetic leases on the aircraft do not currently have, and are not reasonably likely to have, a current or future material effect on Cintas’ financial condition, changes in Cintas’ financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
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 applicants and 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. The court has ordered four of the named plaintiffs to arbitrate their claims. On April 27, 2005, the United States Equal Employment Opportunity Commission (EEOC) intervened in order to participate in this lawsuit. No filings or determination has been made in regard to the lawsuit 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. Several
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related proceedings with similar allegations and seeking similar relief damages and fees are pending, including a class action lawsuit, Mirna E. Serrano, et al., v. Cintas Corporation, filed on May 10, 2004, in the United States District Court for the Eastern District of Michigan, Southern Division on behalf of female service sales representative job applicants at all Cintas locations in Michigan. On September 6, 2005, a Magistrate Judge granted Plaintiffs’ motion for leave to file a second amended complaint to expand the lawsuit to a nationwide claim. On November 15, 2005, the EEOC intervened in Serrano to participate in the lawsuit in continuation of an EEOC charge filed on April 17, 2000, by Mirna Serrano with the EEOC Detroit District office. On February 24, 2006, a motion to intervene in Serrano was filed by intervening Plaintiffs Colleen Grindle, et al., on behalf of a nationwide subclass and an Ohio subclass of female employees in Cintas’ Rental Division who were allegedly denied hire, promotion or transfer to a SSR position. On July 15, 2005, the EEOC terminated the processing of an administrative action filed on December 15, 2004, by James Morgan with the EEOC Washington, D.C. office and the California Department of Fair Employment and Housing alleging racial discrimination in compensation and training opportunities and issued a right to sue letter. On August 3, 2005, Morgan joined the Ramirez lawsuit. On November 2, 2005, the Court entered an order requiring Morgan to arbitrate all of his claims for monetary damages. In addition, a class action lawsuit, Larry Houston, et al., v. Cintas Corporation, was filed on August 3, 2005, in the United States District Court for the Northern District of California on behalf of African-American managers alleging racial discrimination. On November 22, 2005, the Court entered an order requiring the named plaintiffs in the Houston lawsuit to arbitrate all of their claims for monetary damages. If there is an adverse verdict or a negotiated settlement of these actions, the resulting liability and/or any increased costs of operations on an ongoing basis could be material to Cintas. Any estimated liability relating to these proceedings is not determinable at this time.
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As we look forward to the remainder of fiscal 2006, our outlook remains positive, but guarded. Our revenue and profits continue to increase at healthy rates despite the negative impacts from hurricanes Katrina, Rita and Wilma as well as increased energy costs. While these events and circumstances will continue to have an impact on our results, we expect continued growth in revenues and profits in our businesses. Overall performance will be largely driven by external market conditions.
We expect our effective tax rate to be consistent with the year to date level for the remainder of the fiscal year.
Although no shares were repurchased in the third quarter, we will continue to evaluate the stock repurchase program authorized by the Board of Directors in fiscal 2005.
In the marketplace, competition and related pricing pressure will continue; however, we believe cost containment initiatives, technological advances and continued leverage of our infrastructure will soften or offset any impact.
We will continue to supplement our internal growth with strategic acquisitions when appropriate opportunities arise.
Like most other companies, we experienced, and anticipate continuing to experience, increased costs for wages and benefits, including medical benefits. Changes in energy costs and changes in federal and state tax laws also have the potential to impact our results.
Cintas continues to be the target of a corporate unionization campaign by UNITE HERE and the Teamsters unions. These unions are attempting to pressure Cintas into surrendering our employees’ rights to a government-supervised election and unilaterally accept union representation. This is unacceptable. Cintas’ philosophy in regard to unions is straightforward: We believe that employees have the right to say yes to union representation and the freedom to say no. This campaign could be materially disruptive to our business and could materially adversely affect results of operations. We will continue to vigorously oppose this campaign and to defend our employees’ rights.
We believe that the high level of customer service provided by our partners and supported by our infrastructure, quality products, financial resources and corporate culture will provide for continued business success. However, a number of factors influence future revenue, margins and profit which make forecasting difficult.
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
In our normal operations, Cintas has market risk exposure to interest rates. This market risk exposure to interest rates has been previously disclosed on page 64 of our most recent annual report. The exposure to variable interest rates has been mitigated through the termination of the interest rate swap agreements on September 1, 2005.
Through its foreign operations, Cintas is exposed to foreign currency risk. Foreign currency exposures arise from transactions denominated in a currency other than the functional currency and from foreign denominated revenue and profit translated into U.S. dollars. The primary foreign currency to which Cintas is exposed is the Canadian dollar. Cintas does not currently use forward exchange contracts to limit potential losses in earnings or cash flows from foreign currency exchange rate movements.
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ITEM 4.CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
With the participation of Cintas’ management, including Cintas’ Chief Executive Officer and President, Chief Financial Officer, General Counsel and Controllers, Cintas has evaluated the effectiveness of the disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of February 28, 2006. Based on such evaluation, Cintas’ management, including Cintas’ Chief Executive Officer and President, Chief Financial Officer, General Counsel and Controllers, have concluded that Cintas’ disclosure controls and procedures were effective as of February 28, 2006, in ensuring (i) information required to be disclosed by Cintas in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (ii) information required to be disclosed by Cintas in the reports that it files or submits under the Exchange Act is accumulated and communicated to Cintas’ management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Internal Control over Financial Reporting
There were no changes in Cintas’ internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended February 28, 2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. See “Management’s Report on Internal Control over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” on pages 53 and 54 of our most recent annual report.
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”, “seeks”, “could”, “should”, “may” and “will” or the negative versions thereof 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 or implied by this Quarterly Report. Factors that might cause such a difference include, but are not limited to, the possibility of greater than anticipated operating costs including energy costs, lower sales volumes, the performance and costs of integration of acquisitions, fluctuations in costs of materials and labor including increased medical costs, costs and possible effects of union organizing activities, uncertainties regarding any existing or newly-discovered expenses and liabilities related to environmental compliance and remediation, the cost, results and ongoing assessment of internal controls for financial reporting required by the Sarbanes-Oxley Act of 2002, the initiation or outcome of litigation, higher assumed sourcing or distribution costs of products, the disruption of operations from catastrophic events, changes in federal and state tax laws and the reactions of competitors in terms of price and service. Cintas undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.
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Part II. Other Information
Item 1. Legal Proceedings
I. Supplemental Information: We discuss certain legal proceedings pending against us in Part I of this quarterly report on Form 10-Q under the caption “Item 1. Financial Statements,” in Note 9 to our financial statements, which is captioned “Litigation and Other Contingencies,” and refer you to that discussion for important information concerning those legal proceedings, including the basis for such actions and, where known, the relief sought. We provide the following additional information concerning those legal proceedings which sets forth the name of the lawsuit, the court in which the lawsuit is pending and the date on which the petition commencing the lawsuit was filed.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 5. Other Information
Item 6. Exhibits
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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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