Cintas is an American company specialized in the manufacture and sale of workwear and uniforms
Table of Contents
United States
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 30, 2010
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-11399
CINTAS CORPORATION
(Exact name of Registrant as specified in its charter)
WASHINGTON
31-1188630
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
6800 CINTAS BOULEVARD
P.O. BOX 625737
CINCINNATI, OHIO 45262-5737
(Address of principal executive offices)(Zip Code)
(513) 459-1200
(Registrant’s telephone number, including area code)
Indicate by checkmark 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 o
Indicate by a checkmark whether the Registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes x No o
Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o
Smaller Reporting Company o
(Do not check if a smaller reporting company)
Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding December 31, 2010
Common Stock, no par value
145,301,073
TABLE OF CONTENTS
Page No.
Part I.
Financial Information
Item 1.
Financial Statements.
Consolidated Condensed Statements of Income — Three Months and Six Months Ended November 30, 2010 and 2009
3
Consolidated Condensed Balance Sheets — November 30, 2010 and May 31, 2010
4
Consolidated Condensed Statements of Cash Flows — Six Months Ended November 30, 2010 and 2009
5
Notes to Consolidated Condensed Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
25
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
35
Item 4.
Controls and Procedures.
36
Part II.
Other Information
Legal Proceedings.
37
Unregistered Sales of Equity Securities and Use of Proceeds.
Item 5.
Other Information.
Item 6.
Exhibits.
Signatures
38
Exhibits
2
ITEM 1. FINANCIAL STATEMENTS.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Unaudited)
(In thousands except per share data)
Three Months Ended
Six Months Ended
November 30,
2010
2009
Revenue:
Rental uniforms and ancillary products
$
657,847
643,597
1,315,411
1,299,235
Other services
278,719
240,912
545,059
476,843
936,566
884,509
1,860,470
1,776,078
Costs and expenses:
Cost of rental uniforms and ancillary products
377,471
363,728
748,986
726,657
Cost of other services
168,447
150,934
327,165
296,779
Selling and administrative expenses
288,304
259,406
581,729
523,833
Legal settlements, net of insurance proceeds
—
4,052
23,529
Operating income
102,344
106,389
202,590
205,280
Interest income
(394
)
(314
(972
(673
Interest expense
12,161
12,579
24,435
24,617
Income before income taxes
90,577
94,124
179,127
181,336
Income taxes
34,711
36,948
61,984
70,176
Net income
55,866
57,176
117,143
111,160
Basic earnings per share
0.38
0.37
0.78
0.72
Diluted earnings per share
Dividends declared per share
0.49
See accompanying notes.
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands except share data)
November 30, 2010
May 31, 2010
ASSETS
Current assets:
Cash and cash equivalents
260,953
411,281
Marketable securities
23,624
154,806
Accounts receivable, net
402,369
366,301
Inventories, net
208,380
169,484
Uniforms and other rental items in service
364,556
332,106
Income taxes, current
13,765
15,691
Deferred income tax asset
53,346
52,415
Prepaid expenses and other
27,853
22,860
Total current assets
1,354,846
1,524,944
Property and equipment, at cost, net
923,535
894,522
Goodwill
1,435,352
1,356,925
Service contracts, net
104,751
103,445
Other assets, net
109,811
89,900
3,928,295
3,969,736
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable
92,206
71,747
Accrued compensation and related liabilities
53,563
66,924
Accrued liabilities
321,209
244,402
Long-term debt due within one year
1,817
609
Total current liabilities
468,795
383,682
Long-term liabilities:
Long-term debt due after one year
785,222
785,444
Deferred income taxes
145,079
150,560
134,086
116,021
Total long-term liabilities
1,064,387
1,052,025
Shareholders’ equity:
Preferred stock, no par value:
100,000 shares authorized, none outstanding
Common stock, no par value:
425,000,000 shares authorized,
FY 2011: 173,341,299 issued and 145,301,073 outstanding
FY 2010: 173,207,493 issued and 152,869,848 outstanding
135,254
132,058
Paid-in capital
87,219
84,616
Retained earnings
3,125,411
3,080,079
Treasury stock:
FY 2011: 28,040,226 shares
FY 2010: 20,337,645 shares
(1,002,064
(798,857
Other accumulated comprehensive income
49,293
36,133
Total shareholders’ equity
2,395,113
2,534,029
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
November 30, 2009
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
74,563
75,899
Amortization of deferred charges
21,182
20,568
Stock-based compensation
5,799
7,571
(6,277
4,777
Change in current assets and liabilities, net of acquisitions of businesses:
(27,774
(12,843
(38,838
34,874
(30,639
5,495
(4,526
(568
19,765
6,914
(13,458
(1,646
(10,066
25,246
Income taxes payable
2,355
16,728
Net cash provided by operating activities
109,229
294,175
Cash flows from investing activities:
Capital expenditures
(88,134
(48,092
Proceeds from redemption of marketable securities
135,283
25,852
Purchase of marketable securities and investments
(12,472
(53,060
Acquisitions of businesses, net of cash acquired
(88,799
(6,601
Other, net
(6,858
1,053
Net cash used in investing activities
(60,980
(80,848
Cash flows from financing activities:
Proceeds from issuance of debt
1,781
Repayment of debt
(794
(321
Repurchase of common stock
(203,207
(959
1,699
(717
Net cash used in financing activities
(200,521
(1,997
Effect of exchange rate changes on cash and cash equivalents
1,944
939
Net (decrease) increase in cash and cash equivalents
(150,328
212,269
Cash and cash equivalents at beginning of period
129,745
Cash and cash equivalents at end of period
342,014
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation
The consolidated condensed financial statements of Cintas Corporation (Cintas, the Company, we, us or our) included herein have been prepared by Cintas, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) 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 Form 10-K for the fiscal year ended May 31, 2010. A summary of our significant accounting policies is presented beginning on page 39 of that report. There have been no material changes in the accounting policies followed by Cintas during the current 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 consolidated results of the interim periods shown have been made.
2. Fair Value Measurements
Financial Accounting Standards Board Accounting Standard Codification Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. It also establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1 —
Quoted prices in active markets for identical assets or liabilities.
Level 2 —
Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 —
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Cintas’ assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
All financial instruments that are measured at fair value on a recurring basis (at least annually) have been segregated into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the consolidated condensed balance sheet date.
These financial instruments measured at fair value on a recurring basis are summarized below (in thousands):
As of November 30, 2010
Level 1
Level 2
Level 3
Fair Value
Marketable securities:
U.S. municipal bonds
941
Canadian treasury securities
22,184
499
22,683
19
Total assets at fair value
283,137
1,459
284,596
Current Accrued Liabilities
12
Total Liabilities
As of May 31, 2010
21,954
97,791
35,061
132,852
450
509,072
57,465
566,537
Current accrued liabilities
64
Total liabilities at fair value
Cintas’ cash and cash equivalents and marketable securities are generally classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. Cintas does not adjust the quoted market price for such financial instruments.
The funds invested in Canadian marketable securities are not expected to be repatriated, but instead are expected to be invested indefinitely in foreign subsidiaries. Interest, realized gains and losses and declines in value determined to be other than temporary on available-for-sale securities are included in interest income or expense. The cost of the securities sold is based on the specific identification method. The amortized cost basis of the marketable securities as of November 30, 2010 and May 31, 2010, is $23.6 million and $154.9 million, respectively. All contractual maturities are due within one year.
Accounts receivable, net and current accrued liabilities include foreign currency average rate options. The fair value of Cintas’ foreign currency average rate options are based on similar exchange traded derivatives and are, therefore, included within Level 2 of the fair value hierarchy.
The methods described above may produce a fair value that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while Cintas believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the consolidated condensed balance sheet date.
7
3. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share using the two-class method for amounts attributable to Cintas’ common shares (in thousands except per share data):
Basic Earnings per Share
Less dividends to:
Common shares
71,197
Unvested shares
683
Total dividends
71,880
Undistributed net (loss) income
(16,014
45,263
Less: net (loss) income allocated to participating unvested securities
(74
226
204
362
Net (loss) income available to common shareholders
(15,940
56,950
45,059
110,798
Basic weighted average common shares outstanding
145,511
152,866
148,856
152,847
Basic earnings per share:
Common shares — distributed earnings
0.00
Common shares — undistributed earnings
(0.11
0.29
Total common shares
Unvested shares - distributed earnings
Unvested shares - undistributed earnings
Total unvested shares
8
Diluted Earnings per Share
Effect of dilutive securities — employee stock options
Diluted weighted average common shares outstanding
Diluted earnings per share:
0.48
During the six months ended November 30, 2010, Cintas purchased 7,656,193 shares of Cintas common stock under a share buyback program authorized by the Board of Directors on May 2, 2005, and expanded in July 2006.
For the three months ended November 30, 2010 and 2009, 3.5 million and 3.6 million options granted to purchase shares of Cintas common stock were excluded from the computation of diluted earnings per share. For the six months ended November 30, 2010 and 2009, 3.9 million and 4.4 million options granted to purchase shares of Cintas common stock were excluded from the computation of diluted earnings per share. The exercise prices of these options were greater than the average market price of the common shares (anti-dilutive).
9
4. Goodwill, Service Contracts and Other Assets
Changes in the carrying amount of goodwill and service contracts for the six months ended November 30, 2010, by operating segment, are as follows (in thousands):
Rental
First Aid,
Uniforms &
Uniform
Safety &
Ancillary
Direct
Fire
Document
Products
Sales
Protection
Management
Total
Balance as of June 1, 2010
861,117
23,928
181,967
289,913
Goodwill acquired
23,443
17,997
34,904
76,344
Foreign currency translation
577
30
1,476
2,083
Balance as of November 30, 2010
885,137
23,958
199,964
326,293
Service Contracts
48,711
35,599
19,135
Service contracts acquired
3,664
7,327
6,038
17,029
Service contracts amortization
(9,363
(3,376
(4,026
(16,765
809
233
1,042
43,821
39,550
21,380
10
Information regarding Cintas’ service contracts and other assets is as follows (in thousands):
Carrying
Accumulated
Amount
Amortization
Net
Service contracts
364,653
259,902
Noncompete and consulting agreements
73,770
58,701
15,069
Investments(1)
80,302
Other
19,110
4,670
14,440
173,182
63,371
346,569
243,124
68,435
53,425
15,010
68,616
10,516
4,242
6,274
147,567
57,667
(1) Investments at November 30, 2010, include the cash surrender value of insurance policies of $46.0 million, equity method investments of $30.0 million and cost method investments of $4.3 million. Investments at May 31, 2010, include the cash surrender value of insurance policies of $34.3 million, equity method investments of $30.0 million and cost method investments of $4.3 million.
Amortization expense was $21.2 million and $20.6 million for the six months ended November 30, 2010 and 2009, respectively. Estimated amortization expense, excluding any future acquisitions, for each of the next five years is $40.0 million, $33.7 million, $17.1 million, $13.9 million and $11.2 million, respectively.
Investments recorded using the cost method are evaluated for impairment on an annual basis or when indicators of impairment are identified. For the six months ended November 30, 2010 and 2009, no losses due to impairment were recorded.
5. Debt, Derivatives and Hedging Activities
As of August 31, 2010, Cintas had a commercial paper program with availability of $600.0 million that was fully supported by a backup revolving credit facility through a credit agreement with its banking group. The revolving credit facility had an expiration date of February, 2011. This revolving credit facility was renewed on September 27, 2010, with reduced availability of $300.0 million, an accordion feature that allows for a maximum borrowing capacity of $450.0 million and an expiration date of September 26, 2014. As of November 30, 2010 and May 31, 2010, Cintas had no commercial paper outstanding.
11
Cintas used interest rate lock agreements to hedge against movements in the treasury rates at the time Cintas issued its senior notes in fiscal 2002, fiscal 2007 and fiscal 2008. The amortization of the interest rate lock agreements resulted in an increase to other comprehensive income of $0.2 million for both of the three months ended November 30, 2010 and November 30, 2009, respectively, and $0.4 million for both of the six months ended November 30, 2010 and November 30, 2009, respectively.
To hedge the exposure of movements in the foreign currency rates, Cintas at times uses foreign currency hedges. These hedges would reduce the impact on cash flows from movements in the foreign currency exchange rates. Examples of foreign currency hedge instruments that Cintas may use are average rate options and forward contracts. Cintas had average rate options included in accounts receivable, net of less than $0.1 million and $0.5 million as of November 30, 2010 and May 31, 2010, respectively. Cintas also had average rate options included in current accrued liabilities of less than $0.1 million and $0.1 million as of November 30, 2010 and May 31, 2010, respectively. The average rate options that settled during the second quarter decreased foreign currency exchange costs by less than $0.1 million during the three months ended November 30, 2010, and increased foreign currency e xchange costs by $0.1 million during the three months ended November 30, 2009. The average rate options decreased foreign currency exchange costs by less than $0.1 million during the six months ended November 30, 2010, and increased foreign currency exchange costs by $0.1 million during the six months ended November 30, 2009.
Cintas has certain 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. If a default of a significant covenant were to occur, the default could result in an acceleration of the maturity of the indebtedness, impair liquidity and limit the ability to raise future capital. As of November 30, 2010, Cintas was in compliance with all significant debt covenants.
6. Income Taxes
In the normal course of business, Cintas provides for uncertain tax positions and the related interest and adjusts its unrecognized tax benefits and accrued interest accordingly. During the three months ended November 30, 2010, unrecognized tax benefits increased by approximately $1.2 million and accrued interest increased by approximately $0.9 million due to the accrual of additional tax and interest. During the six months ended November 30, 2010, unrecognized tax benefits increased by approximately $2.5 million and accrued interest decreased by approximately $7.9 million due to the expiration of certain statutes.
All U.S. federal income tax returns are closed to audit through fiscal 2008. Cintas is currently in advanced stages of audits in certain foreign jurisdictions and certain domestic states. The years under audit cover fiscal years back to 2000. Based on the resolution of the various audits, it is reasonably possible that the balance of unrecognized tax benefits could decrease by $4.3 million for the fiscal year ending May 31, 2011.
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 income. For Cintas, the only components of total comprehensive income are the change in cumulative foreign currency translation adjustments, the change in the fair value of derivatives, the amortization of interest rate lock agreements and the change in the fair value of available-for-sale securities. The components of comprehensive income for the three and six month periods ended November 30, 2010 and November 30, 2009, are as follows (in thousands):
Other comprehensive income:
Foreign currency translation adjustment
10,025
9,797
13,374
10,526
Change in fair value of derivatives*
(19
(92
(625
(23
Amortization of interest rate lock agreements
191
383
Change in fair value of available-for-sale securities**
1
31
28
18
Comprehensive income
66,064
67,103
130,303
122,064
* Net of less than $0.1 million of tax benefit for both the three months ended November 30, 2010 and November 30, 2009. Net of $0.4 million of tax benefit and net of less than $0.1 million of tax benefit for the six months ending November 30, 2010 and November 30, 2009, respectively.
** Net of less than $0.1 million of tax expense for both the three months ended November 30, 2010 and November 30, 2009. Net of less than $0.1 million of tax expense for the six months ended November 30, 2010 and November 30, 2009, respectively.
8. Litigation and Other Contingencies
Cintas is subject to legal proceedings, insurance receipts, legal settlements 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 operation 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, Mirna E. Serrano, et al. v. Cintas Corporation (Serrano), filed on May 10, 2004, and pending in the United States District Court, Eastern District of Michigan, Southern Division. The Serrano plaintiffs alleged that Cintas discriminated against women in hiring into various service sales representative positions across all divisions of Cintas. On November 15, 2005, the Equal Employment Opportunity Commission (EEOC) intervened in the Serrano lawsuit. The Serrano plaintiffs seek injunctive relief, compensatory damages, punitive damages, attorneys’ fees and
13
other remedies. On October 27, 2008, the United States District Court in the Eastern District of Michigan granted summary judgment in favor of Cintas limiting the scope of the putative class in the Serrano lawsuit to female applicants for service sales representative positions at Cintas locations within the state of Michigan. Consequently, all claims brought by female applicants for service sales representative positions outside of the state of Michigan were dismissed. Similarly, any claims brought by the EEOC on behalf of similarly situated female applicants outside of the state of Michigan have also been dismissed from the Serrano lawsuit. Cintas is a defendant in another purported class action lawsuit, Blanca Nelly Avalos, et al. v. Cintas Corporation (Avalos), which was filed in the United States District Court, Eastern District of Michigan, Southern Divisio n. The Avalos plaintiffs alleged that Cintas discriminated against women, African-Americans and Hispanics in hiring into various service sales representative positions in Cintas’ Rental division only throughout the United States. The Avalos plaintiffs sought injunctive relief, compensatory damages, punitive damages, attorneys’ fees and other remedies. The claims in Avalos originally were brought in the lawsuit captioned Robert Ramirez, et al. v. Cintas Corporation (Ramirez), filed on January 20, 2004, in the United States District Court, Northern District of California, San Francisco Division. On May 11, 2006, the Ramirez and Avalos African-American, Hispanic and female failure to hire into service sales representative positions claims and the EEOC’s intervention were consolidated for pretrial purposes with the Serrano case and transferred to the United States District Court for the Eastern District of M ichigan, Southern Division. The consolidated case was known as Mirna E. Serrano/Blanca Nelly Avalos, et al. v. Cintas Corporation (Serrano/Avalos). On March 31, 2009, the United States District Court, Eastern District of Michigan, Southern Division entered an order denying class certification to all plaintiffs in the Serrano/Avalos lawsuits. Following denial of class certification, the Court permitted the individual Avalos and Serrano plaintiffs to proceed separately. In the Avalos case, the court dismissed the remaining claims of the individual plaintiffs who remained in that case after the denial of class certification. On May 11, 2010, Plaintiff Tanesha Davis, on behalf of all similarly situated plaintiffs in the Avalos case, filed a notice of appeal of the District Court’s summary judgment order in the United States Court of Appeals for the Sixth Circuit. The Appellate Court has made no determinatio n regarding the merits of Davis’ appeal. In September 2010, the Court in Serrano dismissed all private individual claims and all claims of the EEOC and the 13 individuals it claimed to represent. The time for appeal has not yet expired on these Serrano dismissals, but, as of the date of this disclosure, no appeal has been taken.
The litigation discussed above, if decided or settled adversely to Cintas, may, individually or in the aggregate, result in liability material to Cintas’ consolidated financial condition or results of operation and could increase costs of operations on an ongoing basis. Any estimated liability relating to these proceedings is not determinable at this time. 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 interest of Cintas’ shareholders.
Cintas is a defendant in a purported class action lawsuit, Paul Veliz, et al. v. Cintas Corporation (Veliz), 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 April 5, 2004 and February 14, 2006, the Court stayed the claims of all plaintiffs with valid arbitration agreements pending arbitration of those claims. Claims made in the Veliz action, therefore, are pending before the United States District Court, Northern District of California and Judge Bruce Meyerson (Ret.), an Arbitrator selected by the parties. On August 5, 2009, the parties in the Veliz action reached a settlement in principle. When the settlement is fully documented and approved by the Court, the settlement will resolve all claims now pending or that could have been brought relating to the subject matter of the case before the Court and the Arbitrator. The principal terms of the settlement provide for an aggregate cash payment of approximately $24.0 million, which is accrued in current accrued liabilities at November 30, 2010. The pre-tax impact, net of insurance proceeds, was $19.5 million.
14
During the second quarter of fiscal 2010, Cintas had legal settlements that totaled $4.1 million, net of insurance proceeds. None of these settlements were significant individually. These settlements included litigation related to multiple subjects including employment practices and insurance coverage.
9. Segment Information
Cintas classifies its businesses into four operating segments. The Rental Uniforms and Ancillary Products operating segment consists of the rental and servicing of uniforms and other garments including flame resistant clothing, mats, mops and shop towels and other ancillary items. In addition to these rental items, restroom cleaning services and supplies and tile and carpet cleaning services are also provided within this operating segment. The Uniform Direct Sales operating segment consists of the direct sale of uniforms and related items and branded promotional products. The First Aid, Safety and Fire Protection Services operating segment consists of first aid, safety and fire protection products and services. The Document Management Services operating segment consists of document destruction, document imaging and document retention services.
Cintas evaluates the performance of each operating segment based on several factors of which the primary financial measures are operating segment revenue and income before income taxes. The accounting policies of the operating segments are the same as those described in Note 1 entitled Basis of Presentation. Information related to the operations of Cintas’ operating segments is set forth below (in thousands):
Corporate
For the three months ended November 30, 2010
Revenue
108,789
93,315
76,615
Income (loss) before income taxes
78,112
13,279
5,107
5,846
(11,767
For the three months ended November 30, 2009
99,434
81,557
59,921
91,881
10,475
3,018
5,067
(16,317
As of and for the six months ended November 30, 2010
207,569
186,849
150,641
156,330
23,126
8,885
14,249
(23,463
Total assets
2,434,313
262,810
360,908
585,687
284,577
As of and for the six months ended November 30, 2009
188,735
171,558
116,550
194,334
18,564
8,805
7,106
(47,473
2,475,877
141,920
311,870
476,441
480,240
3,886,348
15
10. Supplemental Guarantor Information
Cintas Corporation No. 2 (Corp. 2) is the indirectly, wholly-owned principal operating subsidiary of Cintas. Corp. 2 is the issuer of the $775.0 million of long-term notes, which are unconditionally guaranteed, jointly and severally, by Cintas and its wholly-owned, direct and indirect domestic subsidiaries.
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’ consolidated financial statements. The condensed consolidating financial statements should be read in conjunction with the consolidated 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 on the following pages.
16
CONDENSED CONSOLIDATING INCOME STATEMENT
THREE MONTHS ENDED NOVEMBER 30, 2010
Cintas
Subsidiary
Non-
Corporation
Corp. 2
Guarantors
Eliminations
Consolidated
505,557
131,978
47,427
(27,115
341,415
136,664
28,737
(228,097
Equity in net income of affiliates
(55,866
846,972
268,642
76,164
(311,078
Costs and expenses (income):
329,017
76,972
32,738
(61,256
225,797
115,067
17,317
(189,734
251,458
16,374
21,860
(1,388
40,700
60,229
4,249
(58,700
(159
(189
(46
Interest expense (income)
12,813
(668
28,046
61,086
4,279
9,661
23,843
1,209
(2
18,385
37,243
3,070
(58,698
17
THREE MONTHS ENDED NOVEMBER 30, 2009
494,833
130,484
45,283
(27,003
302,077
81,362
16,173
(158,700
(57,176
796,910
211,846
61,456
(242,879
336,163
79,385
27,500
(79,320
177,729
69,720
10,545
(107,060
346,099
(101,836
15,405
(262
(63,081
160,525
8,006
(56,237
(248
(66
12,763
(200
(75,844
160,973
8,056
(35,690
69,889
2,749
(40,154
91,084
5,307
SIX MONTHS ENDED NOVEMBER 30, 2010
1,012,908
264,212
93,807
(55,516
672,360
258,574
51,517
(437,392
(117,143
1,685,268
522,786
145,324
(610,051
652,149
156,553
62,558
(122,274
439,511
217,859
31,517
(361,722
525,667
16,752
41,847
(2,537
67,941
131,622
9,402
(123,518
(354
(470
(100,179
100,031
25,411
(990
42,884
133,082
109,567
(223,549
13,170
40,870
7,941
29,714
92,212
101,626
(223,552
SIX MONTHS ENDED NOVEMBER 30, 2009
998,683
264,704
88,453
(52,605
598,844
154,823
30,380
(307,204
(111,160
1,597,527
419,527
118,833
(470,969
626,402
159,671
53,323
(112,739
395,888
133,523
19,118
(251,750
597,128
(104,762
30,342
1,125
(21,891
207,566
16,050
(107,605
(531
(142
25,482
(882
(47,373
208,979
16,175
(26,014
90,747
5,443
(21,359
118,232
10,732
20
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF NOVEMBER 30, 2010
Assets
42,387
90,859
127,707
288,898
78,663
34,808
172,010
27,874
10,907
(2,411
282,998
77,440
30,000
(25,882
Income taxes, current (payable)
(4,254
486
17,533
Deferred income tax asset (liability)
55,723
(2,377
5,449
18,458
3,946
787,488
350,444
245,207
(28,293
583,900
262,086
77,549
1,356,331
79,021
97,415
839
6,497
1,880,573
1,630,702
821,743
363,412
(4,586,619
3,099,505
2,791,443
771,686
(4,614,912
Liabilities and Shareholders’ Equity
Accounts (receivable) payable
(465,247
194,410
327,244
(2,224
38,023
37,701
3,283
61,786
224,525
34,898
843
974
294,740
565,322
35,957
795,008
(9,786
139,911
5,168
133,473
613
263,598
5,781
2,345,820
2,009,757
1,962,523
729,948
(4,652,935
21
AS OF MAY 31, 2010
Cintas Corporation
Subsidiary Guarantors
Non-Guarantors
Cintas Corporation Consolidated
34,905
339,702
36,674
265,594
74,256
26,451
144,826
16,857
9,420
(1,619
256,398
70,489
25,514
(20,295
5,306
(591
10,976
Deferred tax asset (liability)
54,474
(2,059
5,565
15,808
1,487
712,594
592,949
241,315
(21,914
591,040
240,462
63,020
1,310,675
46,250
98,335
880
4,230
2,032,649
1,608,188
814,657
322,707
(4,688,301
3,010,157
2,959,623
677,522
(4,710,215
164,131
343,454
(8,614
42,181
21,730
3,013
53,432
178,698
13,092
(820
805
(196
260,549
543,686
7,491
37,203
795,541
(10,917
820
145,563
4,997
115,549
472
250,195
5,469
2,497,896
1,954,067
2,165,742
664,562
(4,748,238
22
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Non- Guarantors
92,211
101,627
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
46,558
22,383
5,622
18,889
339
1,954
(6,731
454
Changes in current assets and liabilities, net of acquisitions of businesses:
(19,216
(4,368
(4,190
(26,531
(11,933
(1,166
792
(26,556
(6,073
(3,597
5,587
188
(2,648
(2,066
75,896
(73,488
17,357
(4,480
(9,151
173
Accrued liabilities and other
(4,734
(7,863
1,711
9,553
(1,076
(6,122
Net cash provided by (used in) operating activities
122,942
99,281
(8,398
111,757
(216,353
(38,392
(43,862
(5,880
21,769
113,514
(17,693
(43,794
49,015
(56,875
(31,924
80,265
21,107
(176,860
(99,528
168,158
Net cash provided by (used in) investing activities
(91,853
(242,747
(23,818
217,173
(495
521
1,316
Net cash (used in) provided by financing activities
(112
2,302
166
1,778
Net increase (decrease) in cash and cash equivalents
7,482
(248,843
91,033
339,701
36,675
90,858
127,708
23
48,525
23,198
4,176
19,033
470
1,065
4,757
15,509
(1,659
1,609
(28,302
40,016
(1,383
(1,831
(1,928
5,809
2,240
(918
(1,636
602
(833
(337
(96,788
80,361
6,650
16,691
(2,092
163
283
(29
25,287
(870
858
7,942
5,978
2,808
118,731
17,168
256,811
23,387
(121,922
(23,471
(21,556
(3,065
Proceeds from sale or redemption of marketable securities
125
25,727
(1,901
(12,401
(23,337
(15,421
(117,772
9,920
6,855
102,079
Net cash (used in) provided by investing activities
(22,053
(26,977
(704
86,658
(471
(36,327
1,213
35,264
384
(3,430
2,329
(87
(39,757
3,542
177
762
(4,795
190,077
26,987
39,397
76,979
13,369
34,602
267,056
40,356
24
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
BUSINESS STRATEGY
Cintas provides highly specialized products and services to businesses of all types primarily throughout North America and Latin America, Europe and Asia. We bring value to our customers by helping them provide a cleaner, safer and more pleasant atmosphere for their customers and employees. Our products and services are designed to improve our customers’ images. We also help our customers protect their employees and their company by enhancing workplace safety and helping to ensure legal compliance in key areas of their business.
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 cleaning services and supplies, tile and carpet cleaning services, first aid, safety and fire protection products and services, document management services and branded promotional products.
Cintas’ principal objective is “to exceed customers’ expectations in order to maximize the long-term value of Cintas for shareholders and working partners,” and it provides the framework and focus for Cintas’ business strategy. This strategy is to achieve revenue growth for all of our products and services by increasing our penetration at existing customers and by broadening our customer base to include business segments to which Cintas has not historically served. We will also continue to identify additional product and service opportunities for our current and future customers.
To pursue the strategy of increasing penetration, we have a highly talented and diverse team of service professionals visiting our customers on a regular basis. This frequent contact with our customers enables us to develop close personal relationships. The combination of our distribution system and these strong customer relationships provides a platform from which we launch additional products and services.
We pursue the strategy of broadening our customer base in several ways. Cintas has a national sales organization introducing all of its products and services to prospects in all business segments. Our broad range of products and services allows our sales organization to consider any type of business a prospect. We also broaden our customer base through geographic expansion, especially in our emerging businesses of first aid and safety, fire protection and document management. Finally, we evaluate strategic acquisitions as opportunities arise.
RESULTS OF OPERATIONS
Cintas classifies its businesses into four operating segments. The Rental Uniforms and Ancillary Products operating segment consists of the rental and servicing of uniforms and other garments including flame resistant clothing, mats, mops and shop towels and other ancillary items. In addition to these rental items, restroom cleaning services and supplies and tile and carpet cleaning services are also provided within this operating segment. The Uniform Direct Sales operating segment consists of the direct sale of uniforms and related items and branded promotional products. The First Aid, Safety and Fire Protection Services operating segment consists of first aid, safety and fire protection products and services. The Document Management Services operating segment consists of document destruction, document imaging and document retention services. Revenue and income before income taxes for e ach of these operating segments for the three and six month periods ended November 30, 2010 and November 30, 2009, are presented in Note 9 entitled Segment Information of “Notes to Consolidated Condensed Financial Statements.”
Consolidated Results
Three Months Ended November 30, 2010 Compared to Three Months Ended November 30, 2009
Total revenue increased 5.9% for the three months ended November 30, 2010, over the same period in the prior fiscal year from $884.5 million to $936.6 million. The increase primarily resulted from an organic growth increase of 4.2%. The remaining 1.7% represents growth derived through acquisitions in our Document Management Services operating segment, our First Aid, Safety and Fire Protection Services operating segment and our Uniform Rentals and Ancillary Products operating segment during the quarter.
Rental Uniforms and Ancillary Products operating segment revenue increased 2.2% for the three months ended November 30, 2010, over the same period in the prior fiscal year from $643.6 million to $657.8 million. Other Services revenue, consisting of revenue from the reportable operating segments of Uniform Direct Sales, First Aid, Safety and Fire Protection Services and Document Management Services, increased 15.7% for the three months ended November 30, 2010, over the same period in the prior fiscal year from $240.9 million to $278.7 million. The increase primarily resulted from an organic increase of 10.4%. The remaining 5.3% represents growth derived through acquisitions in our Document Management Services operating segment and our First Aid, Safety and Fire Protection Services operating segment during the quarter. The organic growth rate for Other Services revenue for the quarter was primar ily the result of a 14.7% increase in Document Management operating segment revenue and a 9.4% increase in Uniform Direct Sales operating segment revenue.
Cost of rental uniforms and ancillary products consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other ancillary items. Cost of rental uniforms and ancillary products increased $13.7 million, or 3.8%, for the three months ended November 30, 2010, compared to the three months ended November 30, 2009. Higher Rental Uniforms and Ancillary Products operating segment volume resulted in an increase in the cost of rental uniforms and ancillary products. In addition, maintenance costs increased $2.6 million and energy related costs increased $1.7 million compared to the three months ended November 30, 2009.
Cost of other services consists primarily of cost of goods sold (predominantly uniforms and first aid products), delivery expenses and distribution expenses in the Uniform Direct Sales operating segment, the First Aid, Safety and Fire Protection Services operating segment and the Document Management Services operating segment. Cost of other services increased $17.5 million, or 11.6%, for the three months ended November 30, 2010, compared to the three months ended November 30, 2009. This increase was primarily due to increased Other Services sales volume.
Selling and administrative expenses increased $28.9 million, or 11.1%, for the three months ended November 30, 2010, compared to the three months ended November 30, 2009. Selling labor and other selling expenses increased by $10.2 million compared to the same period in the prior fiscal year primarily as a result of an increase in the number of sales representatives. In addition, professional services increased $3.1 million due to costs related to our enterprise-wide system conversion and bad debt expense increased $2.4 million due to a slight deterioration in the aging in part resulting from an on-going accounts receivable consolidation project.
Net interest expense (interest expense less interest income) was $11.8 million for the three months ended November 30, 2010, compared to $12.3 million for the three months ended November 30, 2009.
Cintas’ effective tax rate decreased to 38.3% for the three months ended November 30, 2010, compared to 39.3% for the prior year period. This decrease was due to the impact of the closure of certain tax audits during the three months ended November 30, 2010.
Net income decreased $1.3 million, or 2.3%, for the three months ended November 30, 2010, from the same period in the prior fiscal year. Diluted earnings per share were $0.38 for the three months ended November 30, 2010, which was an increase of 2.7% compared to the same period in the prior fiscal year.
26
Rental Uniforms and Ancillary Products Operating Segment
As discussed above, Rental Uniforms and Ancillary Products operating segment revenue increased from $643.6 million to $657.8 million, or 2.2%, and the cost of rental uniforms and ancillary products increased $13.7 million, or 3.8%. The operating segment’s gross margin was $280.4 million, or 42.6% of revenue. This gross margin percent of revenue of 42.6% was 90 basis points lower than the prior fiscal year’s second quarter of 43.5%. Maintenance costs increased $2.6 million, or approximately 30 basis points, and energy related costs, which include natural gas, electric and gas, increased $1.7 million, or approximately 20 basis points, from the prior fiscal year’s second quarter.
Selling and administrative expenses as a percent of revenue, at 30.7%, increased 150 basis points compared to the second quarter of the prior fiscal year. This increase is primarily due to an increase in selling labor due to the addition of sales representatives. The sales representatives were added to grow revenue in the operating segment.
Income before income taxes decreased $13.8 million to $78.1 million for the Rental Uniforms and Ancillary Products operating segment for the quarter compared to the same quarter last fiscal year. Income before income taxes was 11.9% of the operating segment’s revenue, which is a 240 basis point decrease compared to the second quarter of the prior fiscal year. This decrease is primarily due to the increase in selling and administrative expenses and the lower gross margin as a percent of revenue.
Uniform Direct Sales Operating Segment
Uniform Direct Sales operating segment revenue increased from $99.4 million to $108.8 million, or 9.4%, for the three months ended November 30, 2010, over the same quarter in the prior fiscal year due to increased customer orders for uniforms.
Cost of uniform direct sales increased $6.0 million, or 8.5%, for the three months ended November 30, 2010, due to increased Uniform Direct Sales volume. The gross margin as a percent of revenue was 29.9% for the quarter ended November 30, 2010, which is a slight improvement over the 29.3% in the same quarter in the prior fiscal year. This increase is due to an increase in sales volume, which causes the operating segment’s fixed costs to be a lower percent of revenue.
Selling and administrative expenses increased $0.6 million compared to the same quarter last fiscal year. However, selling and administrative expenses decreased as a percent of revenue from 18.8% in the second quarter last year to 17.7% in this year’s second quarter. This decrease in selling and administrative expenses as a percent of revenue was due to the selling and administrative expenses increasing at a lower rate than the revenue growth rate.
Income before income taxes increased $2.8 million to $13.3 million for the Uniform Direct Sales operating segment for the quarter ended November 30, 2010. Income before income taxes was 12.2% of the operating segment’s revenue compared to 10.5% for the same quarter last fiscal year. This increase in income before income taxes is primarily due to the increase in revenue.
First Aid, Safety and Fire Protection Services Operating Segment
First Aid, Safety and Fire Protection Services operating segment revenue increased from $81.6 million to $93.3 million, or 14.4%, for the three months ended November 30, 2010. The increase primarily resulted from organic growth of 8.4%. The remaining 6.0% represents growth derived mainly through acquisitions.
27
Cost of first aid, safety and fire protection services increased $4.0 million, or 7.8%, for the three months ended November 30, 2010. Gross margin for the First Aid, Safety and Fire Protection Services operating segment is defined as revenue less cost of goods, warehouse expenses, service expenses and training expenses. The gross margin as a percent of revenue was 41.1% for the quarter ended November 30, 2010, which is a 360 basis point increase compared to the gross margin percentage in the second quarter of the prior fiscal year. This increase is due to an increase in sales volume, which causes the operating segment’s fixed costs to be a lower percent of revenue, and the elimination of lower margin fire installation revenue.
Selling and administrative expenses as a percent of revenue, at 35.6%, increased 180 basis points compared to the second quarter of the prior fiscal year. Selling and administrative expenses increased from $27.5 million in last year’s second quarter to $33.2 million in the second quarter of this fiscal year due to an increase in the number of sales representatives and a $1.4 million increase in bad debt expense.
Income before income taxes for the First Aid, Safety and Fire Protection Services operating segment increased $2.1 million to $5.1 million for the three months ended November 30, 2010. Income before income taxes was 5.5% of the operating segment’s revenue, compared to 3.7% in last fiscal year’s second quarter. This increase is primarily due to the increase in sales volume.
Document Management Services Operating Segment
Document Management Services operating segment revenue increased from $59.9 million to $76.6 million, or 27.9%, for the quarter ended November 30, 2010, over the same quarter in the prior fiscal year. The increase primarily resulted from an organic growth increase of 14.7%. The remaining 13.2% represents growth derived mainly through acquisitions. This operating segment derives a portion of its revenue from the sale of shredded paper to paper recyclers. The average price from these paper sales increased by approximately 42% in the quarter ended November 30, 2010, compared to the quarter ended November 30, 2009, due to increased volume and increases in recycled paper prices. This increase resulted in higher recycled paper revenue. Excluding the increase in recycled paper prices, operating segment revenue grew 5.0% organically compared to last fiscal year’s second quarter.
Cost of document management services increased $7.5 million, or 25.4%, for the three months ended November 30, 2010, due to increased Document Management Services operating segment volume. Gross margin for the Document Management Services operating segment is defined as revenue less production and service costs. The gross margin as a percent of revenue increased from 50.5% in last year’s second quarter to 51.4% for the quarter ended November 30, 2010. This increase is largely due to the increase in the recycled paper prices which increased overall operating segment revenue.
Selling and administrative expenses increased $8.4 million compared to the same quarter last year primarily due to an increase in the number of sales representatives. These expenses as a percent of revenue, at 43.8%, increased 180 basis points compared to the second quarter of the prior fiscal year.
Income before income taxes for the Document Management Services operating segment increased $0.8 million to $5.9 million for the period compared to the same period in the prior fiscal year. Income before income taxes as a percentage of the operating segment’s revenue decreased from 8.5% in last year’s second quarter to 7.6% for the quarter ended November 30, 2010, primarily as a result of the increase in selling and administrative expenses.
Six Months Ended November 30, 2010 Compared to Six Months Ended November 30, 2009
Total revenue increased 4.8% for the six months ended November 30, 2010, over the same period in the prior fiscal year from $1.8 billion to $1.9 billion. The increase primarily resulted from an organic growth
increase of 3.5%. The remaining 1.3% represents growth derived through acquisitions in our Document Management Services operating segment, our First Aid, Safety and Fire Protection Services operating segment and our Uniform Rentals and Ancillary Products operating segment during the period.
Rental Uniforms and Ancillary Products operating segment revenue increased 1.2% for the six months ended November 30, 2010, over the same period in the prior fiscal year from $1.30 billion to $1.32 billion. Other Services revenue, consisting of revenue from the reportable operating segments of Uniform Direct Sales, First Aid, Safety and Fire Protection Services and Document Management Services, increased 14.3% for the six months ended November 30, 2010, over the same period in the prior fiscal year from $476.8 million to $545.1 million. The increase primarily resulted from an organic increase of 10.4%. The remaining 3.9% represents growth derived through acquisitions in our Document Management Services operating segment and our First Aid, Safety and Fire Protection Services operating segment during the period. The organic growth rate for the quarter was primarily the result of an 18.8% increas e in Document Management operating segment revenue and a 10.0% increase in Uniform Direct Sales operating segment revenue.
Cost of rental uniforms and ancillary products consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other ancillary items. Cost of rental uniforms and ancillary products increased $22.3 million, or 3.1%, for the six months ended November 30, 2010, compared to the six months ended November 30, 2009. Higher Rental Uniforms and Ancillary Products operating segment volume resulted in an increase in the cost of rental uniforms and ancillary products. In addition, maintenance costs increased $5.4 million and energy related costs increased $2.9 million compared to the six months ended November 30, 2009.
Cost of other services consists primarily of cost of goods sold (predominantly uniforms and first aid products), delivery expenses and distribution expenses in the Uniform Direct Sales operating segment, the First Aid, Safety and Fire Protection Services operating segment and the Document Management Services operating segment. Cost of other services increased $30.4 million, or 10.2%, for the six months ended November 30, 2010, compared to the six months ended November 30, 2009. This increase was primarily due to increased Other Services sales volume.
Selling and administrative expenses increased $57.9 million, or 11.1%, for the six months ended November 30, 2010, compared to the six months ended November 30, 2009. Labor and payroll tax expenses increased by $29.2 million compared to the same period in the prior fiscal year primarily as a result of an increase in the number of sales representatives. In addition, bad debt expense increased $6.1 million due to a slight deterioration in the aging in part resulting from an on-going accounts receivable consolidation project, and professional services increased $5.3 million due to costs related to our enterprise wide system conversion.
During the first quarter of fiscal 2010, Cintas and the plaintiffs involved in the litigation, Paul Veliz, et al. v. Cintas Corporation, reached a settlement in principle. The principal terms of the settlement provide for an aggregate cash payment of approximately $24 million, which Cintas has accrued as of November 30, 2010. The pre-tax impact, net of insurance proceeds, was approximately $19.5 million. This settlement is more fully described in Note 8 entitled Litigation and Other Contingencies in “Notes to Consolidated Condensed Financial Statements.” During the second quarter of fiscal 2010, Cintas had legal settlements that totaled $4.1 million, net of insurance proceeds. None of these settlements were significant individually. These settlements included litigation related to multiple subjects including employment practices and insurance coverage.
Net interest expense (interest expense less interest income) was $23.5 million the six months ended November 30, 2010, compared to $23.9 million for the six months ended November 30, 2009.
Cintas’ effective tax rate decreased to 34.6% for the six months ended November 30, 2010, compared to 38.7% for the prior year period. This decrease was due to the impact of the closure of certain tax audits during the six months ended November 30, 2010.
Net income increased $6.0 million, or 5.4%, for the six months ended November 30, 2010, from the same period in the prior fiscal year. Diluted earnings per share were $0.78 for the six months ended November 30, 2010, which was an increase of 8.3% compared to the same period in the prior fiscal year. The
29
increased net income and diluted earnings per share are due primarily to increased revenue for the period, and the legal settlements which occurred last year, offset by higher selling and administrative expenses in the current period.
As discussed above, Rental Uniforms and Ancillary Products operating segment revenue increased from $1.30 billion to $1.32 billion, or 1.2%, and the cost of rental uniforms and ancillary products increased $22.3 million, or 3.1%. The operating segment’s gross margin was $566.4 million, or 43.1% of revenue. This gross margin percent of revenue of 43.1% was 100 basis points lower than the prior fiscal year’s 44.1%. Maintenance costs increased $5.4 million, or approximately 40 basis points, and energy related costs, which include natural gas, electric and gas, increased $2.9 million, or approximately 20 basis points, from the prior fiscal year period.
Selling and administrative expenses as a percent of revenue, at 31.2%, increased 210 basis points compared to the same period of the prior fiscal year. This increase is primarily due to an increase in selling labor due to the addition of sales representatives. The sales representatives were added to grow revenue in the operating segment.
Income before income taxes decreased $38.0 million to $156.3 million for the Rental Uniforms and Ancillary Products operating segment compared to the same period last fiscal year. Income before income taxes was 11.9% of the operating segment’s revenue, which is a 310 basis point decrease compared to the same period of the prior fiscal year. This is primarily due to the increase in selling and administrative expenses and the lower gross margin as a percent of revenue.
Uniform Direct Sales operating segment revenue increased from $188.7 million to $207.6 million, or 10.0%, for the six months ended November 30, 2010, over the same period in the prior fiscal year due to increased customer orders for uniforms.
Cost of uniform direct sales increased $12.8 million, or 9.6%, for the six months ended November 30, 2010, due to increased Uniform Direct Sales volume. The gross margin as a percent of revenue was 30.1% for the six months ended November 30, 2010, which is relatively consistent with the 29.9% in the same period of the prior fiscal year.
Selling and administrative expenses increased $1.5 million compared to last fiscal year. However, selling and administrative expenses decreased as a percent of revenue from 20.1% in the first six months last fiscal year to 19.0% in this fiscal year’s first six months. This decrease in selling and administrative expenses as a percent of revenue was due to the selling and administrative expenses increasing at a lower rate than the revenue growth rate.
Income before income taxes increased $4.6 million to $23.1 million for the Uniform Direct Sales operating segment for the six months ended November 30, 2010. Income before income taxes was 11.1% of the operating segment’s revenue compared to 9.8% for the same period last fiscal year. This increase in income before income taxes is primarily due to the increase in revenue.
First Aid, Safety and Fire Protection Services operating segment revenue increased from $171.6 million to $186.8 million, or 8.9%, for the six months ended November 30, 2010. The increase primarily resulted from an organic growth of 5.1%. The remaining 3.8% represents growth derived mainly through acquisitions.
Cost of first aid, safety and fire protection services increased $4.5 million, or 4.3%, for the six months ended November 30, 2010. Gross margin for the First Aid, Safety and Fire Protection Services operating segment is defined as revenue less cost of goods, warehouse expenses, service expenses and training expenses. The gross margin as a percent of revenue was 41.0% for the six months ended November 30, 2010, which is a 260 basis point increase compared to the gross margin percentage for the six months ended November 30, 2009. This increase is due to an increase in sales volume, which causes the operating segment’s fixed costs to be a lower percent of revenue, and the elimination of lower margin fire installation revenue.
Selling and administrative expenses as a percent of revenue, at 36.2%, increased 300 basis points compared to the first six months of the prior fiscal year. Selling and administrative expenses increased from $57.0 million in last fiscal year’s first six months to $67.7 million in the first six months of this fiscal year due to an increase in the number of sales representatives and a $3.0 million increase in bad debt expense.
Income before income taxes for the First Aid, Safety and Fire Protection Services operating segment increased $0.1 million to $8.9 million for the six months ended November 30, 2010. Income before income taxes was 4.8% of the operating segment’s revenue, compared to 5.1% in last fiscal year’s first six months. This decrease in income before income taxes as a percent of revenue is primarily due to the increase in selling and administrative expenses.
Document Management Services operating segment revenue increased from $116.6 million to $150.6 million, or 29.3%, for the six months ended November 30, 2010, over the same period in the prior fiscal year. The increase primarily resulted from an organic growth increase of 18.8%. The remaining 10.5% represents growth derived mainly through acquisitions. This operating segment derives a portion of its revenue from the sale of shredded paper to paper recyclers. The average price from these paper sales increased by approximately 52% in the six months ended November 30, 2010, compared to the six months ended November 30, 2009, due to increased volume and increases in recycled paper prices. This increase resulted in higher recycled paper revenue. Excluding the increase in recycled paper prices, segment revenue grew 7.8% organically compared to last fiscal year’s first six month s.
Cost of document management services increased $13.1 million, or 22.3%, for the six months ended November 30, 2010, due to increased Document Management Services operating segment volume. Gross margin for the Document Management Services operating segment is defined as revenue less production and service costs. The gross margin as a percent of revenue increased from 49.6% for the six months ended November 30, 2009, to 52.3% for the six months ended November 30, 2010. This increase is due to the increase in the recycled paper prices which increased revenue.
Selling and administrative expenses increased $13.8 million compared to last fiscal year primarily due to an increase in the number of sales representatives. However, these expenses as a percent of revenue, at 42.9%, decreased 60 basis points compared to the first six months of the prior fiscal year. This decrease is due to the revenue growing at a faster rate than the expenses due to the increase in recycled paper prices.
Income before income taxes for the Document Management Services operating segment increased $7.1 million to $14.2 million for the period compared to the same period in the prior fiscal year. Income before income taxes as a percentage of the operating segment’s revenue increased from 6.1% in last year’s first six months to 9.5% for the six months ended November 30, 2010, primarily as a result of the increase in recycled paper prices.
Liquidity and Capital Resources
The following is a summary of our cash flows and cash and cash equivalents and marketable securities as of and for the six months ended November 30, 2010 (in thousands):
Cash and cash equivalents and marketable securities at the end of the period
566,087
The cash and cash equivalents and marketable securities as of November 30, 2010, include $152 million that is located outside of the United States. We expect to use these amounts to fund our international operations and expansion activities. The marketable securities at November 30, 2010, consist of United States municipal bonds and Canadian treasury securities. We believe that our investment policy pertaining to marketable securities is conservative. The criterion used in making investment decisions is the preservation of principal, while earning an attractive yield.
Cash flows provided by operating activities have historically supplied us with a significant source of liquidity. We generally use these cash flows to fund most, if not all, of our operations and expansion activities and dividends on our common stock. We may also use cash flows provided by operating activities, as well as proceeds from long-term debt and short-term borrowings, to fund growth and expansion opportunities, as well as other cash requirements such as share buybacks.
Net cash provided by operating activities was $109.2 million for the six months ended November 30, 2010, a decrease of $184.9 million compared to the same period last fiscal year. Last fiscal year’s net cash provided by operating activities benefitted from lower working capital needs associated with our decreasing sales volumes and the accrual of approximately $28 million in legal settlements. As sales volumes have increased this fiscal year, our working capital needs have increased. Accounts receivable has increased $36.1 million since May 31, 2010, and inventories, net and uniforms and other rental items in service has increased $71.3 million since May 31, 2010, both due to the higher sales volumes and an intentional increase in inventory in anticipation of and as a precaution to a planned enterprise-wide system conversion of the Cintas global supply chain division.
Net cash used in investing activities includes capital expenditures and cash paid for acquisitions of businesses. Capital expenditures were $88.1 million and $48.1 million for the six months ended November 30, 2010 and 2009, respectively. These capital expenditures primarily relate to expansion efforts in Rental Uniforms and Ancillary Products and Document Management Services operating segments and to an enterprise wide system conversion. Capital expenditures increased this year compared to last year as economic conditions in the United States and Canada stabilized in 2010, providing better revenue growth opportunities. Cash paid for acquisitions of businesses was $88.8 million and $6.6 million for the six months ended November 30, 2010 and 2009, respectively. The acquisitions this fiscal year occurred in our Document Management Services, First Aid, Safety and Fire Protection Services an d Rental Uniforms and Ancillary Products operating segments. The cash used for capital expenditures and acquisitions was offset by net proceeds from the sale or redemption of marketable securities.
Net cash used in financing activities was $200.5 million and $2.0 million for the six months ended November 30, 2010 and 2009, respectively. We completed our existing share buyback program by
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purchasing $203.3 million of Cintas common stock during the six months ended November 30, 2010. We incurred no new debt or short-term borrowings during the period to finance these purchases, but instead used existing cash and cash equivalents.
On October 26, 2010, we announced that the Board of Directors authorized a $500 million share buyback program at market prices. No purchases have been made under this new program.
On October 26, 2010, Cintas declared an annual cash dividend of $0.49 per share on outstanding common stock, a two percent increase over the dividend paid in the prior year. The dividend was paid on December 15, 2010, to shareholders of record as of November 12, 2010.
As of November 30, 2010, we had $775.0 million in fixed rate notes outstanding with maturities ranging from 2012 to 2036. Cintas had a commercial paper program with availability of $600.0 million that was fully supported by a backup revolving credit facility through a credit agreement with its banking group. This revolving credit facility was renewed on September 27, 2010, with availability of $300.0 million and an accordion feature that allows for a maximum borrowing capacity of $450.0 million and an expiration date of September 26, 2014. The availability was reduced from $600.0 million to $450.0 million in order to lower the overall cost of the program. We believe this program will be adequate to provide necessary funding for our cash requirements. As of November 30, 2010 and May 31, 2010, we had no commercial paper outstanding and no outstanding borrowings on our revolving credit facility.& #160; However, as a result of cash requirements related primarily to acquisition opportunities, we have issued commercial paper subsequent to November 30, 2010, for varying amounts with a maximum outstanding issuance of approximately $90.0 million.
Our access to the commercial paper and long-term debt markets has historically provided us with sources of liquidity. We do not anticipate having difficulty in obtaining financing from those markets in the future in view of our favorable experiences in the debt markets in the recent past. Our ability to continue to access the commercial paper and long-term debt markets on favorable interest rate and other terms will depend, to a significant degree, on the ratings assigned by the credit rating agencies to our indebtedness. As of November 30, 2010, our ratings were as follows:
Rating Agency
Outlook
Commercial Paper
Long-term Debt
Standard & Poor’s
Stable
A-2
A-
Moody’s Investors Service
P-1
A2
In the event that the ratings of our commercial paper or our outstanding long-term debt issues were substantially lowered or withdrawn for any reason or if the ratings assigned to any new issue of long-term debt securities were significantly lower than those noted above, particularly if we no longer had investment grade ratings, our ability to access the debt markets may be adversely affected. In addition, in such a case, our cost of funds for new issues of commercial paper and long-term debt would be higher than our cost of funds would have been had the ratings of those new issues been at or above the level of the ratings noted above. The rating agency ratings are not recommendations to buy, sell or hold our commercial paper or debt securities. Each rating may be subject to revision or withdrawal at any time by the assigning rating organization and should be evaluated independently of any other rat ing. Moreover, each credit rating is specific to the security to which it applies.
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To monitor our credit rating and our capacity for long-term financing, we consider various qualitative and quantitative factors. One such factor is the ratio of our total debt to capitalization. For the purpose of this calculation, debt is defined as the sum of short-term borrowings, long-term debt due within one year, obligations under capital leases due in one year, long-term debt and long-term obligations under capital leases. Total capitalization is defined as debt plus shareholders’ equity. At November 30, 2010 and May 31, 2010, the ratio of our total debt to capitalization was 24.7% and 23.7%, respectively. We believe these levels are reasonable and allow for additional funding if the need arises.
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. Please refer to Note 8 entitled Litigation and Other Contingencies of “Notes to Consolidated Condensed Financial Statements” for a detailed discussion of certain specific litigation.
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Forward-Looking Statements
This Quarterly Report on Form 10-Q contains 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,” “predicts,” “projects,” “plans,” “expects,” “intends,” “target,” “forecast,” “believes,” “seeks,” “could,” “should,” “may” and “will” or the negative versions thereof and similar words, terms and 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. You should not place undue reliance on any forward-looking statement. We cannot gua rantee that any forward-looking statement will be realized. These statements are subject to various risks, uncertainties, potentially inaccurate assumptions 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, loss of customers due to outsourcing trends, 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, failure to comply with government regulations concerning employment discrimination, employee pay and benefits and employee health and safety, uncertainties regarding any existing or newly-discovered expenses and liabilities related to environmental compliance and remediation, the cost, results and ongoing ass essment of internal controls for financial reporting required by the Sarbanes-Oxley Act of 2002, disruptions caused by the unaccessibility of computer systems data, the initiation or outcome of litigation, investigations or other proceedings, higher assumed sourcing or distribution costs of products, the disruption of operations from catastrophic or extraordinary events, changes in federal and state tax and labor laws and the reactions of competitors in terms of price and service. Cintas undertakes no obligation to publicly release any revisions to any forward-looking statements or to otherwise update any forward-looking statements whether as a result of new information or to reflect events, circumstances or any other unanticipated developments arising after the date on which such statements are made. A further list and description of risks, uncertainties and other matters can be found in our Annual Report on Form 10-K for the year ended May 31, 2010 and in our reports on Forms 10-Q and 8-K. The risks and uncertainties described herein are not the only ones we may face. Additional risks and uncertainties presently not known to us or that we currently believe to be immaterial may also harm our business.
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 material change to this market risk exposure to interest rates from that which was previously disclosed on page 30 of our Form 10-K for the year ended May 31, 2010.
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 currency denominated revenue and profit translated into U.S. dollars. The primary foreign currency to which Cintas is exposed is the Canadian dollar. Cintas has average rate options in place to limit a portion of the risks of the revenue translation from Canadian foreign currency exchange rate movements during the remainder of the fiscal year; however, the amount of these options is not significant.
ITEM 4.
CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
With the participation of Cintas’ management, including Cintas’ Chief Executive Officer, 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 (Exchange Act)) as of November 30, 2010. Based on such evaluation, Cintas’ management, including Cintas’ Chief Executive Officer, Chief Financial Officer, General Counsel and Controllers, has concluded that Cintas’ disclosure controls and procedures were effective as of November 30, 2010, 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)&nb sp;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 November 30, 2010, 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 32 and 33 of our Form 10-K for the fiscal year ended May 31, 2010.
Part II. Other Information
Item 1. Legal Proceedings.
I. Supplemental Information: We discuss material legal proceedings (other than ordinary routine litigation incidental to our business) pending against us in “Item 1. Financial Statements,” in Note 8 entitled Litigation and Other Contingencies of “Notes to Consolidated Condensed Financial Statements.” We refer you to and incorporate by reference into this Part II, Item 1 that discussion for important information concerning those legal proceedings.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On May 2, 2005, Cintas announced that the Board of Directors authorized a $500 million share buyback program at market prices. In July 2006, Cintas announced that the Board of Directors approved the expansion of its share buyback program by an additional $500 million. The Board did not specify an expiration date for this program.
Period
Total number of shares purchased
Average price paid per share
Total number of shares purchased as part of the publicly announced plan
Maximum approximate dollar value of shares that may yet be purchased under the plan
September 2010
2,711,262
26.51
27,951,175
October 2010
November 2010
For the three months ended November 30, 2010, Cintas purchased 2,711,262 shares of Cintas common stock under this program at an average price of $26.51 per share for a total purchase price of $71.9 million. From the inception of the share buyback program through December 31, 2010, Cintas has purchased a total of approximately 28.0 million shares of Cintas stock at an average price of $35.78 per share for a total purchase price of $1 billion. These purchases in September completed the existing share buyback program. On October 26, 2010, Cintas announced that the Board of Directors authorized a $500 million share buyback program at market prices. No purchases have been made under this new program.
Item 5. Other Information
Item 6. Exhibits.
10.1
Fourth Amendment Agreement to Credit Agreement, dated as of September 27,2010 (Incorporated by reference to Exhibit 10.5 to Cintas’ Form 8-K dated October 1, 2010)
31.1
Certification of Principal Executive Officer required by Rule 13a-14(a)
31.2
Certification of Principal Financial Officer required by Rule 13a-14(a)
32.1
Section 1350 Certification of Chief Executive Officer
32.2
Section 1350 Certification of Chief Financial Officer
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.
(Registrant)
Date: January 7, 2011
By:
/s/ William C. Gale
William C. Gale
Senior Vice President and Chief Financial Officer
(Chief Accounting Officer)
EXHIBIT INDEX
Fourth Amendment Agreement to Credit Agreement, dated as of September 27, 2010 (Incorporated by reference to Exhibit 10.5 to Cintas’ Form 8-K dated October 1, 2010)
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