filings.toolsItem 7. Management's Discussion and Analysis
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Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations
Business Strategy
Cintas helps more than 900,000 businesses of all types and sizes, primarily in North America, as well as Latin America, Europe and Asia, get Ready™ to open their doors with confidence every day by providing a wide range of products and services that enhance our customers’ image and help keep their facilities and employees clean, safe and looking their best. With products and services including uniforms, floor care, restroom supplies, first aid and safety products, fire extinguishers and testing, and safety and compliance training, Cintas helps customers get Ready for the Workday™.
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, carpet and tile cleaning services, first aid and safety services and fire protection products and services.
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 we have 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 our 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 first aid and safety and fire protection businesses. Finally, we evaluate strategic acquisitions as opportunities arise.
Results of Operations
GAAP requires companies to evaluate their reportable operating segments periodically and when certain events occur. As a result of a recent evaluation, effective June 1, 2015, Cintas realigned its organizational structure and updated its reportable operating segments in light of certain changes in its business including the acquisition of ZEE in the first quarter of fiscal 2016. Cintas’ updated reportable operating segments are Uniform Rental and Facility Services and First Aid and Safety Services. The Uniform Rental and Facility Services reportable 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, carpet and tile cleaning services and the sale of items from our catalogs to our customers on route are included within this reportable operating segment. The First Aid and Safety Services reportable operating segment consists of first aid and safety products and services. The remainder of Cintas’ business, which consists primarily of Fire Protection Services and its Direct Sale business, is included in All Other. All prior fiscal year results presented in the table on page 15 have been recast to reflect these new reportable operating segments. Cintas evaluates operating segment performance based on revenue and income before income taxes. Revenue and income before income taxes for each of these reportable operating segments for the years ended May 31, 2016, 2015, and 2014 are presented in Note 14 entitled Operating Segment Information of "Notes to Consolidated Financial Statements." The Company regularly reviews its operating segments for reporting purposes based on the information its chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance and makes changes when appropriate.
Prior to June 1, 2015, Cintas classified its business into the following three reportable operating segments: the Rental Uniforms and Ancillary Products operating segment consisted 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 carpet and tile cleaning services were also provided within this operating segment. The Uniform Direct Sales operating segment consisted of the direct sale of uniforms and related items. The First Aid and Safety and Fire Protection Services operating segment consisted of first aid and safety products and services, and fire protection products and services.
Shred-it and the results of Shredding are classified as discontinued operations for all periods presented as a result of selling the investment during fiscal 2016. During fiscal 2015, Cintas sold Storage and, as a result, its operations are also classified as discontinued operations for all periods presented. Shredding and Storage were previously included in the former Document Management Services reportable operating segment. In accordance with the applicable accounting guidance for the disposal of long-lived assets and discontinued operations, the results of Shredding and Storage have been excluded from both continuing operations and operating segment results for all periods presented. Please see Note 16 entitled Discontinued Operations of "Notes to Consolidated Financial Statements" for additional information.
The following table sets forth certain consolidated statements of income data as a percent of revenue by reportable operating segment, All Other and in total for the fiscal years ended May 31:
| 2016(1) | 2015(1)(2) | 2014(1)(2) | ||||||
| Revenue: | ||||||||
| Uniform Rental and Facility Services | 77.0 | % | 79.1 | % | 78.8 | % | ||
| First Aid and Safety Services | 9.4 | % | 7.3 | % | 7.0 | % | ||
| All Other | 13.6 | % | 13.6 | % | 14.2 | % | ||
| Total revenue | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cost of sales: | ||||||||
| Uniform Rental and Facility Services | 55.8 | % | 56.7 | % | 58.2 | % | ||
| First Aid and Safety Services | 57.3 | % | 53.4 | % | 53.8 | % | ||
| All Other | 60.7 | % | 61.2 | % | 61.1 | % | ||
| Total cost of sales | 56.6 | % | 57.1 | % | 58.3 | % | ||
| Gross margin: | ||||||||
| Uniform Rental and Facility Services | 44.2 | % | 43.3 | % | 41.8 | % | ||
| First Aid and Safety Services | 42.7 | % | 46.6 | % | 46.2 | % | ||
| All Other | 39.3 | % | 38.8 | % | 38.9 | % | ||
| Total gross margin | 43.4 | % | 42.9 | % | 41.7 | % | ||
| Selling and administrative expenses: | ||||||||
| Uniform Rental and Facility Services | 26.4 | % | 26.2 | % | 26.0 | % | ||
| First Aid and Safety Services | 31.9 | % | 32.8 | % | 32.6 | % | ||
| All Other | 30.4 | % | 31.4 | % | 32.1 | % | ||
| Total selling and administrative expenses | 27.5 | % | 27.4 | % | 27.4 | % | ||
| Gain on sale of stock of an equity method investment | — | % | 0.5 | % | — | % | ||
| Interest expense, net | 1.3 | % | 1.4 | % | 1.5 | % | ||
| Income from continuing operations before income taxes | 14.6 | % | 14.6 | % | 12.8 | % |
| (1) | The figures for all years presented reflect the change in classification of Shred-it, Shredding and Storage to discontinued operations within the Consolidated Statements of Income. See Note 16 entitled Discontinued Operations of "Notes to Consolidated Financial Statements." |
| (2) | Cintas' reportable operating segments changed effective June 1, 2015. All prior fiscal periods have been recast to reflect that change. |
Fiscal 2016 Compared to Fiscal 2015
Fiscal 2016 total revenue was $4.9 billion, an increase of 9.6% over the prior fiscal year. Revenue increased organically by 6.7% as a result of increased sales volume. Organic growth adjusts for the impact of acquisitions, divestitures, workday differences and foreign currency exchange rate fluctuations. Total revenue was positively impacted by 2.7% due to acquisitions and 0.9% due to two more workdays in fiscal 2016 compared to fiscal 2015. Revenue growth was also negatively impacted by 0.7% due to foreign currency exchange rate fluctuations.
Organic growth by quarter is shown in the table below.
| Organic Growth | |
| First Quarter Ending August 31, 2015 | 6.8% |
| Second Quarter Ending November 30, 2015 | 6.5% |
| Third Quarter Ending February 29, 2016 | 6.8% |
| Fourth Quarter Ending May 31, 2016 | 6.7% |
| For the Fiscal Year Ending May 31, 2016 | 6.7% |
Uniform Rental and Facility Services reportable operating segment revenue consists predominantly of revenue derived from the rental of corporate identity uniforms and other garments, including flame resistant clothing, and the rental and/or sale of mats, mops, shop towels, restroom supplies and other rental services. Revenue from the Uniform Rental and Facility Services reportable operating segment increased 6.7% compared to fiscal 2015. The increase resulted from an organic growth increase in revenue of 6.4%. The amount of new business grew, resulting from an increase in the number and productivity of sales representatives. Generally, sales productivity improvements are the result of increased tenure and improved training, which result in a higher number of products and services sold. Revenue growth was negatively impacted 0.8% due to foreign currency exchange rate fluctuations. Revenue was positively impacted by 0.3% due to acquisitions and 0.8% due to two more workdays in fiscal 2016 compared to the same period in the prior fiscal year.
Other revenue, consisting of revenue from the First Aid and Safety Services reportable operating segment and All Other, increased 20.3% compared to fiscal 2015. Revenue increased organically by 8.0% due primarily to improved sales representative productivity. Revenue growth was negatively impacted by 0.4% due to foreign currency exchange rate fluctuations. Acquisitions positively impacted the growth rate by 11.8%, and two more workdays in fiscal 2016 positively impacted growth by 1.0% compared to fiscal 2015.
Cost of uniform rental and facility services increased 4.9% compared to fiscal 2015. Cost of uniform rental and facility services consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other ancillary items. The cost of uniform rental and facility services increase compared to fiscal 2015 was due to increased Uniform Rental and Facility Services reportable operating segment sales volume.
Cost of other consists primarily of cost of goods sold (predominantly first aid and safety products, uniforms and fire protection products), delivery expenses and distribution expenses in the First Aid and Safety Services reportable operating segment and All Other. Cost of other services increased 22.1% in fiscal 2016 compared to fiscal 2015. The increase was primarily related to the increased sales volumes in the First Aid and Safety Services segment and All Other.
Selling and administrative expenses increased $123.2 million, or 10.1%, compared to fiscal 2015 due primarily to increases in labor and other employee-partner related expenses.
During fiscal 2015, Cintas sold stock in an equity method investment. In conjunction with the sale of the equity method investment, the Company received a cash dividend. The sale resulted in the recording of a gain of $21.7 million in fiscal 2015.
Net interest expense (interest expense less interest income) was $63.6 million in fiscal 2016 compared to $64.8 million in fiscal 2015. The decrease in net interest expense is primarily due to the capitalization of $1.1 million of interest in fiscal year 2016 versus $0.6 million of interest in fiscal 2015.
Income before income taxes was $718.1 million, an increase of $64.8 million, or 9.9%, compared to fiscal 2015. The increase in income before income taxes was due primarily to revenue growing at a faster rate than expenses.
Cintas' effective tax rate on continuing operations was 36.4% for fiscal 2016 compared to 37.2% in fiscal 2015. The decrease in fiscal 2016 was primarily the result of the benefit derived from the closing of a prior-year Federal tax audit. See Note 8 entitled Income Taxes of "Notes to Consolidated Financial Statements" for more information.
Net income from continuing operations for fiscal 2016 of $456.9 million was an 11.3% increase compared to fiscal 2015. Diluted earnings per share from continuing operations of $4.09 was an 18.2% increase compared to fiscal 2015. Diluted earnings per share from continuing operations increased due to an increase in earnings from continuing operations combined with a decrease in weighted average common shares outstanding. The decrease in weighted average common shares outstanding resulted from purchasing 8.7 million shares of common stock under the January 13, 2015 and August 4, 2015 share buyback programs since the beginning of the fiscal 2016.
Uniform Rental and Facility Services Reportable Operating Segment
Uniform Rental and Facility Services reportable operating segment revenue increased $238.0 million, or 6.7%, and the cost of uniform rental and facility services increased $99.2 million, or 4.9%. The reportable operating segment's fiscal 2016 gross margin was 44.2% of revenue compared to 43.3% in fiscal 2015. The 90 basis point improvement was driven by many factors, including new business sold by sales representatives, penetration of additional products and services into existing customers, and continuously improving the efficiency of internal processes. In addition, lower energy-related expenses increased gross margin 50 basis points.
Selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment increased $71.9 million in fiscal 2016 compared to fiscal 2015 primarily due to increases in labor and other employee-partner related expenses. Selling and administrative expense as a percent of revenue for fiscal 2016 was 26.4% compared to 26.2% in fiscal 2015.
Income before income taxes increased $66.9 million to $672.9 million for fiscal 2016 compared to fiscal 2015. Income before income taxes as a percent of revenue, at 17.8%, increased 70 basis points from 17.1% in fiscal 2015. This increase is primarily due to the increase in gross margin discussed above.
First Aid and Safety Services Reportable Operating Segment
First Aid and Safety Services reportable operating segment revenue increased $135.2 million in fiscal 2016, a 41.4% increase compared to fiscal 2015. Revenue increased organically by 9.7% as a result of increased sales volume. Revenue growth was positively impacted by 1.1% due to two more workdays in fiscal 2016 compared to fiscal 2015. The remaining 30.6% increase in growth represents growth derived through acquisitions, primarily the ZEE acquisition.
Cost of first aid and safety services increased $90.5 million, or 51.9%, in fiscal 2016, due primarily to increased First Aid and Safety Services reportable operating segment volume. Gross margin for the First Aid and Safety Services reportable 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 42.7% for fiscal 2016 compared to 46.6% in fiscal 2015. ZEE integration costs and the lower efficiency of the acquired ZEE routes were primarily responsible for the decrease in gross margin.
Selling and administrative expenses increased by $40.3 million, or 37.6%, in fiscal 2016 compared to fiscal 2015 primarily due to an increase in labor, other employee-partner related expenses and costs associated with the integration of ZEE. Selling and administrative expenses as a percent of revenue, at 31.9%, decreased from 32.8% in fiscal 2015, as revenue growth outpaced the increase in expenses.
Income before income taxes was $49.5 million in fiscal 2016, an increase of $4.4 million, or 9.7%, compared to fiscal 2015. Income before income taxes as a percent of revenue, at 10.7%, decreased from 13.8% in fiscal 2015, due to the decrease in gross margin discussed above.
Fiscal 2015 Compared to Fiscal 2014
Fiscal 2015 total revenue was $4.5 billion, an increase of 6.7% over the prior fiscal year. Revenue increased organically by 7.1% as a result of increased sales volume. Organic growth excludes the impact of acquisitions, divestitures and foreign currency exchange rate fluctuations. Revenue growth was negatively impacted by 0.5% due to foreign currency exchange rate fluctuations. Acquisitions positively impacted the growth rate by 0.1%.
Organic growth by quarter is shown in the table below.
| Organic Growth | |
| First Quarter Ending August 31, 2014 | 7.3% |
| Second Quarter Ending November 30, 2014 | 7.2% |
| Third Quarter Ending February 28, 2015 | 7.5% |
| Fourth Quarter Ending May 31, 2015 | 6.0% |
| For the Fiscal Year Ending May 31, 2015 | 7.1% |
Uniform Rental and Facility Services reportable operating segment revenue consists predominantly of revenue derived from the rental of corporate identity uniforms and other garments, including flame resistant clothing, and the rental and/or sale of mats, mops, shop towels, restroom supplies and other rental services. Revenue from the Uniform Rental and Facility Services reportable operating segment increased 7.1% compared to fiscal 2014. The increase resulted from an organic growth increase in revenue of 7.6%. The amount of new business grew, resulting from an increase in the number and productivity of sales representatives. Generally, sales productivity improvements are the result of increased tenure and improved training, which result in a higher number of products and services sold. Revenue in fiscal 2015 was positively impacted by 1.0% due to acquisitions and negatively impacted by 0.5% due to foreign currency exchange rate fluctuations.
Other revenue, consisting of revenue from the First Aid and Safety Services reportable operating segment and All Other, increased 5.4% compared to fiscal 2014. The increase primarily resulted from an organic growth increase of 4.9%, which was due largely to improved sales representative productivity. Revenue in fiscal 2015 was negatively impacted by 0.3% due to foreign currency exchange rate fluctuations. Acquisitions positively impacted the growth rate by 0.8%
Cost of uniform rental and facility services increased 4.4% compared to fiscal 2014. Cost of uniform rental and facility services consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other ancillary items. The increase in the cost of uniform rental and facility services compared to fiscal 2014 was due to increased Uniform Rental and Facility Services reportable operating segment sales volume.
Cost of other services increased 5.0% compared to fiscal 2014. Cost of other consists primarily of cost of goods sold (predominantly first aid and safety products, uniforms and fire protection products), delivery expenses and distribution expenses in the First Aid and Safety Services reportable operating segment and All Other. The increase from fiscal 2014 was primarily due to increased First Aid and Safety Services reportable operating segment sales volume.
Selling and administrative expenses increased $77.9 million, or 6.8%, compared to fiscal 2014 due primarily to increases in labor and other employee-partner related expenses.
Operating income of $696.4 million in fiscal 2015 increased $93.7 million, or 15.5%, compared to fiscal 2014.
Net interest expense (interest expense less interest income) was $64.8 million in fiscal 2015 compared to $65.6 million in fiscal 2014. The decrease in net interest expense is primarily due to the capitalization of $0.6 million of interest in fiscal year 2015 versus no capitalization of interest in fiscal 2014.
Income before income taxes was $653.3 million, an increase of $116.2 million, or 21.6%, compared to fiscal 2014. The increase in income before income taxes was primarily due to revenue growing at a faster rate than expenses.
Cintas' effective tax rate in fiscal 2015 was 37.2%, which was comparable to the effective tax rate of 37.1% in fiscal 2014. See Note 8 entitled Income Taxes of "Notes to Consolidated Financial Statements" for more information on income taxes.
Net income from continuing operations for fiscal 2015 of $410.5 million was a 21.5% increase compared to fiscal 2014. Diluted earnings per share from continuing operations of $3.46 was a 25.8% increase compared to fiscal 2014. The increase in diluted earnings per share is higher than the increase in net income due to a decrease in weighted average common stock outstanding as a result of Cintas purchasing 10.3 million shares of common stock under the October 18, 2011, July 30, 2013 and January 13, 2015 share buyback programs during fiscal 2015 and the fourth quarter of fiscal 2014.
Uniform Rental and Facility Services Reportable Operating Segment
Uniform Rental and Facility Services reportable operating segment revenue increased $235.2 million, or 7.1%, and the cost of uniform rental and facility services increased $85.2 million, or 4.4%. Revenue in fiscal 2015 was negatively affected by 0.5% due to foreign currency exchange rate changes compared to fiscal 2014. The reportable operating segment's fiscal 2015 gross margin was 43.3% of revenue compared to 41.8% in fiscal 2014. The increase in gross margin as a percent of revenue over fiscal 2014 was due to new business sold by sales representatives, penetration of additional products and services into existing customers, and continuously improving the efficiency of internal processes. In addition, lower energy-related expenses increased gross margin 40 basis points.
Selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment increased $65.9 million in fiscal 2015 compared to fiscal 2014 primarily due to increases in labor and other employee-partner related expenses. Selling and administrative expense as a percent of revenue for fiscal 2015 was 26.2% compared to 26.0% in fiscal 2014.
Income before income taxes increased $84.2 million to $606.0 million for fiscal 2015 compared to fiscal 2014. Income before income taxes as a percent of revenue, at 17.1%, increased from 15.8% in fiscal 2014. This increase is primarily due to the increase in gross margin.
First Aid and Safety Services Reportable Operating Segment
First Aid and Safety Services reportable operating segment revenue increased $31.6 million in fiscal 2015, a 10.7% increase compared to fiscal 2014. Revenue increased organically by 10.6% due to improvements in sales representative productivity. Acquisitions resulted in revenue growth of 0.1%.
Cost of first aid and safety services increased $15.4 million, or 9.7%, in fiscal 2015, due primarily to increased First Aid and Safety Services reportable operating segment volume. Gross margin for the First Aid and Safety Services reportable 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 46.6% for fiscal 2015 compared to 46.2% in fiscal 2014. Energy-related expenses decreased 40 basis points from fiscal 2014 and were the primary driver of gross margin improvement in fiscal 2015.
Selling and administrative expenses increased by $11.0 million, or 11.4%, in fiscal 2015 compared to fiscal 2014 primarily due to an increase in labor and other employee-partner related expenses. Selling and administrative expenses as a percent of revenue, at 32.8%, increased slightly from 32.6% in fiscal 2014.
Income before income taxes was $45.1 million in fiscal 2015, an increase of $5.2 million, or 13.1%, compared to fiscal 2014. Income before income taxes as a percent of revenue, at 13.8%, increased from 13.5% in fiscal 2014.
Liquidity and Capital Resources
The following is a summary of our cash flows and cash, cash equivalents and marketable securities as of and for the fiscal years ending May 31:
| (In thousands) | 2016 | 2015 | |||||
| Net cash provided by operating activities | $ | 465,845 | $ | 580,276 | |||
| Net cash provided by investing activities | $ | 128,381 | $ | 44,987 | |||
| Net cash used in financing activities | $ | (866,724 | ) | $ | (712,560 | ) | |
| Cash and cash equivalents at the end of the period | $ | 139,357 | $ | 417,073 | |||
| Marketable securities at the end of the period | $ | 70,405 | $ | 16,081 |
Cash, cash equivalents and marketable securities as of May 31, 2016 and 2015 include $96.5 million and $109.8 million, respectively, that is located outside of the United States. We expect to use these amounts to fund our international operations and international expansion activities.
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, 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 the repurchase of our common stock.
Net cash provided by operating activities was $465.8 million for fiscal 2016, which was a decrease of $114.4 million compared to fiscal 2015. Net cash provided by operating activities was negatively impacted by the $229.5 million payment of taxes due on the gain on the sale of Shred-it. Excluding the impact of this tax payment, net cash provided by operations increased $115.0 million as a result of increased net income, partially offset by changes in working capital.
Net cash of $128.4 million was provided by investing activities in fiscal 2016, compared to $45.0 million in fiscal 2015. Capital expenditures were $275.4 million and $217.7 million for fiscal 2016 and fiscal 2015, respectively. Capital expenditures for fiscal 2016 included $237.9 million for the Uniform Rental and Facility Services reportable operating segment and $22.4 million for the First Aid and Safety Services reportable operating segment. Cash paid for acquisitions of businesses was $156.6 million and $15.5 million for fiscal 2016 and fiscal 2015, respectively. The acquisitions in both fiscal 2016 and 2015 occurred in our Uniform Rental and Facility Services reportable operating segment, our First Aid and Safety Services reportable operating segment and our Fire Protection business, which is included in All Other. In fiscal 2016, net cash provided by investing activities included $580.8 million of proceeds related to the sale of Shred-it. In addition, there was $35.3 million of cash received from the sale of the Storage real estate assets classified as held for sale at May 31, 2015 and additional consideration received from the sale of Storage in fiscal 2015. In fiscal 2015, net cash provided by investing activities include $35.2 million cash received from the sale of stock of an equity method investment plus receipt of dividends on the same investment. The Company sold Storage during fiscal 2015, receiving proceeds, net of cash contributed, of $158.4 million. Also, during fiscal 2015, net cash provided by investing activities include a dividend received from Shred-it of $113.4 million. Net cash provided by investing activities for fiscal 2016 and 2015 include net purchases of marketable securities and investments of $60.0 million and $33.5 million, respectively.
Net cash used in financing activities was $866.7 million and $712.6 million for fiscal 2016 and 2015, respectively. On July 30, 2013, Cintas announced that the Board of Directors approved a $500.0 million share buyback program. From April 2014 through February 2015, Cintas purchased a total of 7.3 million shares of Cintas common stock at an average price of $68.29 per share for a total purchase price of $500.0 million. These purchases completed the July 30, 2013 share buyback program. On January 13, 2015, we announced that the Board of Directors authorized a $500.0 million share buyback program. From the inception of the January 13, 2015 share buyback program through September 2015, Cintas purchased a total of 5.9 million shares of Cintas common stock at an average price of $84.07 per share for a total purchase price of $500.0 million. On August 4, 2015, we announced that the Board of Directors authorized a new $500.0 million share buyback program, which does not have an expiration date. From the inception of the August 4, 2015 share buyback program, through May 31, 2016, Cintas has purchased a total of 5.6 million shares of Cintas common stock at an average price of $87.85 per share for a total purchase price of $496.3 million. The August 4, 2015 plan was completed in June 2016. From the inception of the August 4, 2015 program through June 1, 2016, Cintas purchased a total of 5.7 million shares of Cintas common stock at an average price of $87.89 per share for a total p
urchase price of $500.0 million. For the fiscal year ended May 31, 2016, Cintas acquired 0.2 million shares of Cintas common stock in satisfaction of employee payroll taxes due on restricted stock awards that vested during the fiscal year. These shares were acquired at an average price of $86.07 per share for a total purchase price of $20.9 million.
On October 14, 2015, Cintas declared an annual cash dividend of $1.05 per share on outstanding common stock, a 23.5% increase over the annual dividend paid in the prior year. The total dividend of $1.05 per share was paid on December 4, 2015, to shareholders of record as of November 6, 2015. This marked the 33rd consecutive year that Cintas has increased its annual dividend, every year since going public in 1983.
As of May 31, 2016, we had $1,300.0 million aggregate principal amount in fixed rate senior notes outstanding with maturities ranging from 2016 to 2036. These senior notes are comprised of $250.0 million of 30-year senior notes issued in fiscal 2007 at a rate of 6.15%, $300.0 million of 10-year senior notes issued in fiscal 2008 at a rate of 6.125%, $250.0 million of 5-year senior notes issued in fiscal 2011 at a rate of 2.85%, $250.0 million of 10-year senior notes issued in 2011 at a rate of 4.30% and $250.0 million of 10-year senior notes issued in fiscal 2012 at a rate of 3.25%. On June 1, 2016, Cintas paid the $250.0 million 5-year senior notes issued in fiscal 2011 with cash and $218.5 million proceeds from the issuance of commercial paper.
Cintas' commercial paper program has a capacity of $300.0 million that is fully supported by a backup revolving credit facility through a credit agreement with its banking group. This revolving credit facility has an accordion feature that allows for a maximum borrowing capacity of $450.0 million. The revolving credit facility was amended on May 29, 2014 to extend that maturity date from October 6, 2016 to May 28, 2019, to adjust the applicable margin used to calculate the interest payable on any outstanding loans, and to adjust the facility fee payable under the agreement. In June 2016, the revolving credit facility was amended to extend the maturity date from May 28, 2019 to June 22, 2021, increase the capacity to $450.0 million, and add an accordion feature that allows for a maximum borrowing capacity of $600.0 million. We believe that this program, along with cash generated from operations, will be adequate to provide necessary funding for our future cash requirements. No commercial paper or borrowings on our revolving credit facility were outstanding at May 31, 2016 or 2015.
Cintas has certain covenants related to debt agreements. These covenants limit our 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 earnings before interest, taxes, depreciation and amortization (EBITDA) 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 May 31, 2016, Cintas was in compliance with all debt covenants.
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 May 31, 2016, our ratings were as follows:
| Rating Agency | Outlook | Commercial Paper | Long-term Debt | |||
| Standard & Poor's | Stable | A-2 | A- | |||
| Moody's Investors Service | Stable | 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 rating. Moreover, each credit rating is specific to the security to which it applies.
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 EBITDA. 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.
Long-Term Contractual Obligations
| Payments Due by Period | |||||||||||||||||||
| (In thousands) | Total | One year or less | Two to three years | Four to five years | After five years | ||||||||||||||
| Long-term debt (1) | $ | 1,300,000 | $ | 250,000 | $ | 300,000 | $ | — | $ | 750,000 | |||||||||
| Operating leases (2) | 134,044 | 30,540 | 47,592 | 29,015 | 26,897 | ||||||||||||||
| Interest payments (3) | 467,438 | 56,188 | 86,875 | 68,500 | 255,875 | ||||||||||||||
| Unconditional purchase obligations | — | — | — | — | — | ||||||||||||||
| Total long-term contractual cash obligations | $ | 1,901,482 | $ | 336,728 | $ | 434,467 | $ | 97,515 | $ | 1,032,772 |
Cintas also makes payments to defined contribution plans. The amount of contributions made to the defined contribution plans are at the discretion of the Board of Directors of Cintas. Future contributions are expected to be $46.9 million in the next year, $100.9 million in the next two to three years, and $111.2 million in the next four to five years.
| (1) | Long-term debt consists of $1,300.0 million in senior notes (reference Note 6 entitled Long-Term Debt and Derivatives of "Notes to Consolidated Financial Statements" for a detailed discussion of long-term debt). |
| (2) | Operating leases consist primarily of operational facility leases. |
| (3) | Interest payments could include interest on both fixed and variable rate debt. As of May 31, 2016, Cintas did not have commercial paper outstanding, and therefore did not have any variable rate debt. |
Other Commitments
| Amount of Commitment Expiration per Period | |||||||||||||||||||
| (In thousands) | Total | One year or less | Two to three years | Four to five years | After five Years | ||||||||||||||
| Lines of credit (1) | $ | 299,899 | $ | — | $ | 299,899 | $ | — | $ | — | |||||||||
| Standby letters of credit (2) | 83,396 | 83,396 | — | — | — | ||||||||||||||
| Total other commitments | $ | 383,295 | $ | 83,396 | $ | 299,899 | $ | — | $ | — |
| (1) | Back-up facility for the commercial paper program (reference Note 6 entitled Long-Term Debt and Derivatives of "Notes to Consolidated Financial Statements" for further discussion). |
| (2) | Support certain outstanding debt (reference Note 6 entitled Long-Term Debt and Derivatives of "Notes to Consolidated Financial Statements"), self-insured workers' compensation and general liability insurance programs. |
Inflation and Changing Prices
Changes in wages, benefits and energy costs have the potential to materially impact Cintas' consolidated financial results. Management believes inflation has not had a material impact on Cintas' consolidated financial condition or a negative impact on consolidated results of operations.
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 consolidated financial position, consolidated results of operations or consolidated cash flows of Cintas.
New Accounting Standards
In February 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income." ASU 2013-02 requires an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income if the item reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For reclassification items not required under GAAP to be reclassified directly to net income in their entirety in the same reporting period, an entity is required to cross-reference to other disclosures currently required under GAAP that provide additional detail about those amounts. The Company adopted
ASU 2013-02 effective June 1, 2013. See Note 13 entitled Accumulated Other Comprehensive Income (Loss) of "Notes to Consolidated Financial Statements" for details of the required disclosure.
In April 2014, the FASB issued ASU 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity,” which amended accounting guidance related to the reporting of discontinued operations and disclosures of disposals of components of an entity. The amended guidance changes the thresholds for disposals to qualify as discontinued operations and requires additional disclosures. This guidance is effective for reporting periods beginning after December 15, 2014 and is required to be applied prospectively. Cintas adopted ASU 2014-08 during the quarter ended August 31, 2015 and applied the amended accounting guidance to Shred-it and will apply it to future transactions, as appropriate.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," to clarify revenue recognition principles. This guidance is intended to improve disclosure requirements and enhance the comparability of revenue recognition practices. Improved disclosures under the amended guidance relate to the nature, amount, timing and uncertainty of revenue that is recognized from contracts with customers. This guidance will be effective for reporting periods beginning after December 15, 2017 and will be required to be applied retrospectively. Early application of the amendments in this update is not permitted. Cintas is currently evaluating the impact that ASU 2014-09 will have on its consolidated financial statements.
In April 2015, the FASB issued ASU 2015-17, “Balance Sheet Classifications of Deferred Taxes,” which amended accounting guidance related to the presentation of deferred tax liabilities and assets. The amended guidance requires that all deferred tax liabilities and assets be classified as noncurrent on the balance sheet. This guidance is effective for reporting periods beginning after December 15, 2016; however, early adoption is permitted. This guidance can also be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. Cintas adopted ASU 2015-17 during the quarter ended November 30, 2015 and has applied this amended accounting guidance to its deferred tax liabilities and assets for all periods presented. The impact of this change in accounting principle on balances previously reported as of May 31, 2015 was a reclassification of $112.4 million from current liabilities to long term liabilities.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. Topic 842 supersedes the previous leases standard, ASC 840, "Leases". This guidance is effective for reporting periods beginning after December 15, 2018. However, early adoption is permitted. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. Cintas is currently evaluating the impact that ASU 2016-02 will have on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, "Improvements to Employee Share-Based Payment Accounting." ASU 2016-09 is intended to simplify accounting for share-based payments. Upon adoption, ASU 2016-09 will require that excess tax benefits for share-based payments be recorded as a reduction of income tax expense and reflected within operating cash flows rather than being recorded within equity and reflected within financing cash flows. The standard also permits the repurchase of more of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity on our cash flows statement, and provides an accounting policy election to account for forfeitures as they occur. This update is effective for interim and annual periods beginning after December 15, 2016; however, early adoption is permitted. The Company is currently assessing the effect that adoption of ASU 2016-09 will have on its consolidated financial statements.
No other new accounting pronouncement recently issued or newly effective had or is expected to have a material impact on the Consolidated Financial Statements.
Critical Accounting Policies and Estimates
The preparation of Cintas' consolidated financial statements in conformity with GAAP requires management to make estimates and judgments that have a significant effect on the amounts reported in the consolidated financial statements and accompanying notes. These critical accounting policies should be read in conjunction with Note 1 entitled Significant Accounting Policies of "Notes to Consolidated Financial Statements." Significant changes, estimates or assumptions related to any of the following critical accounting policies could possibly have a material impact on the consolidated financial statements.
Revenue recognition
Rental revenue, which is recorded in the Uniform Rental and Facility Services reportable operating segment, is recognized when services are performed. Other revenue, which is recorded in the First Aid and Safety Services reportable operating segments and All Other, is recognized when either services are performed or when products are shipped and the title and risks of ownership pass to the customer.
Allowance for doubtful accounts
Cintas establishes an allowance for doubtful accounts. This allowance includes an estimate based on historical rates of collections and allowances for specific accounts identified as uncollectible. The allowance that is an estimate based on the Company's historical rates of collections is recorded for overdue amounts, beginning with a nominal percentage and increasing substantially as the account ages. The amount provided as the account ages will differ slightly between the Uniform Rental and Facility Services reportable operating segment, the First Aid and Safety Services reportable operating segment and All Other because of differences in customers served and the nature of each business. When an account is considered uncollectible, it is written off against the allowance for doubtful accounts.
Inventories
Inventories are valued at the lower of cost (first-in, first-out) or market. Cintas applies a commonly accepted practice of using inventory turns to apply variances between actual and standard costs to the inventory balances. The judgments and estimates used to calculate inventory turns will have an impact on the valuation of inventories at the lower of cost or market. An inventory obsolescence reserve is determined by specific identification, as well as an estimate based on the Company's historical rates of obsolescence.
Uniforms and other rental items in service
Uniforms and other rental items in service are valued at cost less amortization, calculated using the straight-line method. Uniforms in service (other than cleanroom and flame resistant clothing) are amortized over their useful life of 18 months. Other rental items, including shop towels, mats, mops, cleanroom garments, flame resistant clothing, linens and restroom dispensers, are amortized over their useful lives, which range from 8 to 60 months. The amortization rates used are based on industry experience, Cintas' specific experience and wear tests performed by Cintas. These factors are critical to determining the amount of in service inventory and related cost of uniforms and ancillary products that are presented in the consolidated financial statements.
Property and equipment
Depreciation is calculated using the straight-line method over the estimated useful lives of the assets based on industry and Company specific experience, which is typically 30 to 40 years for buildings, 5 to 20 years for building improvements, 3 to 10 years for equipment and 2 to 15 years for leasehold improvements. When events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable, the estimated undiscounted future cash flows are compared to the carrying amount of the assets. If the estimated undiscounted future cash flows are less than the carrying amount of the assets, an impairment loss is recorded based on the excess of the carrying amount of the assets over their respective fair values. Fair value is generally determined by discounted cash flows or based on prices of similar assets, as appropriate.
Investments
Investments consists primarily of the cash surrender value of life insurance policies and equity method investments. The equity method is used to account for an investment if our investment gives us the ability to exercise significant influence over the operating and financial policies of the investee. In general, equity method investments are initially measured at cost. However, an equity method investment resulting from a transaction in which a controlled group of assets that constitutes a business is deconsolidated is initially measured at fair value. Cintas recognizes its share of the investee’s earnings or losses in income. Cintas also adjusts its share of the investee's earnings for intra-entity
transactions, basis differences, investee capital transactions and other comprehensive income through income or other comprehensive income as appropriate. Equity method investments are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment might not be recoverable.
Goodwill
Goodwill, obtained through acquisitions of businesses, is valued at cost less any impairment. Cintas completes an annual impairment test, which may include an assessment of qualitative factors including, but not limited to, macroeconomic conditions, industry and market conditions, and entity specific factors such as strategies and financial performance. The test may also include the determination of the estimated fair value of Cintas' reporting units via comparisons to current market values, where available, and discounted cash flow analyses. Significant assumptions may include growth rates based on historical trends and margin improvement leveraged from such growth, as well as discount rates. We determine discount rates separately for each reporting unit using the weighted average cost of capital, which includes a calculation of cost of equity, which is developed using the capital asset pricing model and comparable company betas (a measure of systemic risk), and cost of debt. We also use comparable market earnings multiple data and our market capitalization to corroborate our reporting unit valuations. We test for goodwill impairment at the reporting unit level. As a result of Cintas’ operating segment realignment, the composition of Cintas’ reporting units for the evaluation of goodwill impairment has changed. Historically, Cintas’ reporting units were the same as the reportable operating segments, Rental Uniforms and Ancillary Products, Uniform Direct Sales and First Aid, Safety and Fire Protection Services. Effective June 1, 2015, Cintas identified five reporting units for purposes of evaluating goodwill impairment, Uniform Rental and Facility Services, First Aid and Safety Services, and three reporting units within All Other. As a result of the change in reporting units, Cintas was required to perform an interim impairment test on Goodwill at June 1, 2015. There was no impairment recorded as a result of the interim impairment test. Based on the results of the annual impairment tests, Cintas was not required to recognize an impairment of goodwill for the fiscal years ended May 31, 2016, 2015 or 2014. Cintas will continue to perform impairment tests as of March 1 in future years or when indicators of impairment exist.
Service contracts and other assets
Service contracts and other assets, which consist primarily of noncompete and consulting agreements obtained through acquisitions of businesses, are amortized by use of the straight-line method over the estimated lives of the agreements, which are generally 5 to 10 years. Certain noncompete agreements, as well as all service contracts, require that a valuation be determined using a discounted cash flow model. The assumptions and judgments used in these models involve estimates of cash flows and discount rates, among other factors. Because of the assumptions used to value these intangible assets, actual results over time could vary from original estimates. Impairment of service contracts and other assets is accomplished through specific identification. No impairment has been recognized by Cintas for the fiscal years ended May 31, 2016, 2015 or 2014.
General insurance liabilities
General insurance liabilities represent the estimated ultimate cost of all asserted and unasserted claims incurred, primarily related to worker's compensation, auto liability and other general liability exposure through the consolidated balance sheet dates. Our reserves are estimated through actuarial procedures of the insurance industry and by using industry assumptions, adjusted for specific expectations based on our claims history. Cintas records an increase or decrease in selling and administrative expenses related to development of prior claims, higher claims activity and other environmental factors in the period in which it becomes known. These changes in estimates may be material to the consolidated financial statements.
Stock-based compensation
Compensation expense is recognized for all share-based payments to employees, including stock options and restricted stock awards, in the consolidated statements of income based on the fair value of the awards that are granted. The fair value of stock options is estimated at the date of grant using the Black-Scholes option-pricing model. Measured compensation cost, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period of the related share-based compensation award. See Note 12 entitled Stock-Based Compensation of "Notes to Consolidated Financial Statements" for further information.
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. GAAP requires that a liability for contingencies be recorded when it is probable that a liability has occurred and the amount of the liability can be reasonably estimated.
Significant judgment is required to determine the existence of a liability, as well as the amount to be recorded. While a significant change in assumptions and judgments could have a material impact on the amounts recorded for contingent liabilities, Cintas does not believe that they will result in a material adverse effect on the consolidated financial statements.
Income taxes
Deferred tax assets and liabilities are determined by the differences between the consolidated financial statement carrying amounts and the tax basis of assets and liabilities. See Note 8 entitled Income Taxes of "Notes to Consolidated Financial Statements" for the types of items that give rise to significant deferred income tax assets and liabilities. Deferred income taxes are classified as assets or liabilities based on the classification of the related asset or liability for financial reporting purposes. Cintas regularly reviews deferred tax assets for recoverability based upon projected future taxable income and the expected timing of the reversals of existing temporary differences. Although realization is not assured, management believes it is more likely than not that the recorded deferred tax assets, as adjusted for valuation allowances, will be realized.
Accounting for uncertain tax positions requires the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the consolidated financial statements. Companies may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.
Cintas is periodically reviewed by domestic and foreign tax authorities regarding the amount of taxes due. These reviews include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposure associated with various filing positions, Cintas records reserves as deemed appropriate. Based on Cintas' evaluation of current tax positions, Cintas believes its tax related accruals are appropriate.
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