Cintas Corporation — Fiscal 2018 Second Quarter Form 10-Q
Reporting period: Three and six months ended November 30, 2017. The filing is unaudited. Cintas provides uniform rental and facility services, first aid and safety services, fire protection services, and direct-sale uniforms, primarily in North America.
Financial performance and liquidity
| Metric | Three months ended Nov. 30, 2017 | Year-over-year change | Six months ended Nov. 30, 2017 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $1,606.4 million | 26.4% | $3,217.9 million | 26.8% |
| Operating income | $235.2 million | 17.3% | $484.3 million | 19.8% |
| Income from continuing operations | $137.7 million | 12.9% | $298.8 million | 15.8% |
| Net income | $137.1 million | (2.3%) | $354.3 million | 27.2% |
| Diluted EPS from continuing operations | $1.24 | 10.7% | $2.69 | 14.0% |
| Diluted EPS | $1.23 | (4.7%) | $3.19 | 25.1% |
- Consolidated operating margin was approximately 14.6% for the quarter and 15.0% for the six-month period, compared with approximately 15.8% and 15.9%, respectively, in the prior-year periods.
- Six-month cash flow from operations was $379.0 million, compared with $301.7 million in the prior year. Capital expenditures were $132.5 million, and investing activities used $6.2 million after $127.8 million of proceeds from the sale of Discontinued Services.
- Cash and cash equivalents were $236.0 million at November 30, 2017, and marketable securities were $22.7 million. Approximately $133.1 million of cash, cash equivalents and marketable securities was held outside the United States.
- Total debt was $2.834 billion, consisting of $300.0 million due within one year and $2.534 billion due thereafter. The company had no commercial paper or revolving credit borrowings at November 30, 2017 and was in compliance with debt covenants.
- On December 1, 2017, after the quarter-end, Cintas repaid $300.0 million of maturing senior notes using cash on hand and $265.0 million of commercial paper proceeds.
- The annual dividend declared was $1.62 per share, an increase of 21.8% from the prior year. The filing also reports $35.7 million of common stock acquired for employee payroll-tax withholding, not open-market repurchases under the $500 million authorization.
Material changes versus the prior comparable period
- The March 21, 2017 acquisition of G&K Services for approximately $2.1 billion substantially increased reported revenue and debt. Acquisition-related revenue contributed approximately 18.4% of second-quarter growth and 18.6% of six-month growth.
- Organic revenue growth was 7.7% in the quarter and 8.0% for the six months. Foreign currency translation added 0.3% and 0.2%, respectively.
- Uniform Rental and Facility Services revenue increased 30.8% in the quarter and 31.4% for the six months. Its quarterly gross margin declined to 44.7% from 44.9%, primarily because G&K had lower margins. Segment income before taxes increased 15.2% in the quarter, but its margin declined to 15.6% from 17.7%.
- First Aid and Safety Services revenue increased 11.5% in the quarter and 12.0% for the six months. Its quarterly gross margin improved to 46.9% from 46.1%, and its pretax margin improved to 12.9% from 11.8%.
- G&K transaction and integration expenses increased to $13.1 million in the quarter and $17.0 million for the six months, compared with $3.3 million and $6.1 million, respectively. Management stated that these expenses reduced second-quarter diluted EPS by $0.07 and six-month diluted EPS by $0.10 after tax.
- Net interest expense rose to $28.8 million in the quarter and $58.9 million for the six months, primarily because of debt issued to finance G&K.
- Discontinued Services was sold during the first quarter of fiscal 2018. Six-month discontinued-operations income was $55.5 million, including a $99.1 million pretax gain on sale; the prior-year six-month amount included a $25.9 million pretax gain related to Shred-it.
Outlook, management commentary, risks and unusual items
- Management’s strategy emphasizes organic growth through customer retention, new business, expanded penetration of existing customers, geographic expansion and selective acquisitions. No specific revenue or earnings guidance is provided in the filing.
- Management expects the Tax Cuts and Jobs Act to reduce future cash taxes and have a positive cash-flow impact, but was still evaluating deferred-tax remeasurement, transition-tax and foreign-earnings effects as of the filing.
- The G&K purchase-price allocation remained preliminary. The acquisition generated $1.520 billion of preliminary goodwill and $536.0 million of identifiable intangible assets, including $519.0 million of service contracts.
- Key risks include execution of G&K integration and realization of synergies, further integration costs, labor and material cost inflation, customer losses from outsourcing, fuel and energy costs, union activity, regulatory compliance, foreign exchange, cybersecurity and SAP implementation risks, litigation, environmental matters, catastrophic events, tax-law changes and access to debt markets.
- The company disclosed a contingent opportunity for additional Shred-it consideration, but no gain was recorded because the amount and receipt remain uncertain.
- Revenue recognition under the new customer-contract standard was preliminarily expected not to have a material impact. Cintas planned adoption in fiscal 2019 using the modified retrospective method. Lease accounting effects were still under evaluation.
- Management stated that ordinary-course litigation and claims are not expected to have a material adverse effect, although outcomes remain uncertain. Disclosure controls were effective as of November 30, 2017, with no material change in internal control over financial reporting.
Investor verification points
- Verify the sustainability of reported growth after separating G&K acquisition contributions from organic growth.
- Track whether G&K integration expenses decline and whether Uniform Rental and Facility Services margins recover from acquisition-related dilution.
- Assess post-quarter-end refinancing of the $300 million maturity and the resulting commercial-paper balance and interest cost.
- Reconcile reported net income and EPS with discontinued-operations gains, acquisition costs, tax effects and other discrete items.
- Review the final G&K purchase-price allocation, goodwill and intangible-asset amortization assumptions.
- Monitor the impact of the Tax Cuts and Jobs Act, including deferred-tax remeasurement and cash-tax benefits.
- Review debt ratings, covenant compliance, interest coverage and liquidity under potential operating or credit-market stress.