G&K Services, Inc. (NASDAQ: GK) today reported operating results for the first quarter of its fiscal year 2017, which ended on October 1, 2016. First quarter revenue grew 1.6 percent to $241.0 million, compared to $237.2 million in last year’s first quarter. Earnings per diluted share were $0.50, compared to $0.80 in the prior year period. First quarter earnings included $0.24 per share of merger-related costs, a previously disclosed $0.19 per share pension settlement charge, and a $0.04 per share benefit due to the adoption of a new accounting standard for employee share-based payments. Excluding these items, adjusted non-GAAP earnings grew 11 percent to $0.89 per diluted share (see reconciliation table).
“Our first quarter results demonstrate the underlying strength of our business, as our team continued to deliver solid profitability improvements and adjusted earnings growth,” said Douglas A. Milroy, Chairman and Chief Executive Officer. “We remain confident that our pending merger with Cintas will be completed and look forward to closing the transaction later this fiscal year.”
Income Statement Review
The first quarter organic growth rate, which adjusts for the impact of currency exchange, acquisitions and divestitures, was 1.6 percent.
First quarter operating margin, including the impact of merger-related costs and the pension settlement charge, was 7.7 percent. Excluding these items, adjusted operating margin improved to 12.7 percent, compared to 11.8 percent in last year’s first quarter (see reconciliation table). The improvement in adjusted operating margin was primarily driven by lower rental merchandise expense, decreased selling costs, and operating leverage from revenue growth.
Interest expense in the quarter increased to $2.0 million, compared to $1.6 million in the prior year quarter, primarily due to a higher effective interest rate from an interest rate swap contract that became effective during the quarter. This swap contract limits the company’s interest rate risk by effectively converting variable rate debt to a fixed rate.
As previously disclosed, in an effort to reduce the risk in its pension plan the company offered former employees who were vested in the plan the opportunity to receive a lump-sum payment of their entire pension benefit. For those plan participants who elected the lump-sum distribution, payments were made during the first quarter, which resulted in an after-tax settlement loss of $3.8 million, or $0.19 per share, that was recognized in the quarter. All payments were made from pension plan trust assets.
Also during the quarter, the company adopted Accounting Standards Update 2016-09 (ASU 2016-09), Improvements to Employee Share-Based Payment Accounting. The adoption of this guidance is expected to increase the volatility of the company’s effective tax rate, as the excess tax benefit related to stock options exercised and vested restricted stock are recorded as income tax expense and no longer in equity. During the first quarter, the adoption had a favorable impact on the company’s effective tax rate, which increased earnings by $0.04 per share. This favorable impact on the tax rate was offset by the tax impact of non-deductible merger-related costs. The result of these two adjustments increased the first quarter effective tax rate to 39.6 percent, compared to 38.0 percent in the prior year.
Balance Sheet and Cash Flow
The company ended the quarter with total debt, net of cash, of $193.4 million and a ratio of debt to total capital of 35.7 percent. Net debt was reduced by $13.5 million during the quarter.
Cash provided by operating activities increased 61 percent to $31.2 million, compared to $19.4 million in the prior year quarter. The increase was primarily driven by improved utilization of merchandise in service, improved collections of accounts receivable and an increase in accounts payable. Capital expenditures were $8.9 million, compared to $13.8 million in the first quarter last year. During the quarter the company paid dividends of $7.7 million, or $0.39 per share. In connection with the proposed merger with Cintas Corporation, the company has suspended activity under its share repurchase program.
roposed Merger with Cintas Corporation
On August 16, 2016, G&K Services announced an agreement under which Cintas Corporation will acquire G&K for $97.50 per share in an all-cash transaction valued at approximately $2.2 billion, including G&K’s outstanding indebtedness. The transaction is expected to close not later than the second quarter of calendar year 2017, subject to approval by the holders of G&K Services’ common stock, required regulatory approvals, and other customary closing conditions.
Outlook
Due to the planned merger with Cintas, G&K has withdrawn all financial guidance.
Due to the planned merger with Cintas, the company will not host a conference call this quarter.
About G&K Services, Inc.
G&K Services, Inc. is a service-focused market leader of branded uniform and facility services programs in the United States and Canada. Headquartered in Minneapolis, Minnesota, G&K Services has 8,000 employees serving customers from 160 facilities in North America. G&K Services is a publicly held company traded over the NASDAQ Global Select Market under the symbol GK and is a component of the Standard & Poor’s SmallCap 600 Index. For more information visitwww.gkservices.com.