Cintas Corporation — Fiscal 2019 First Quarter 10-Q
Reporting period: Three months ended August 31, 2018, compared with the three months ended August 31, 2017. Cintas provides uniform rental and facility services, first aid and safety services, fire protection services, and uniform direct sales, primarily in North America. Results include the G&K Services acquisition completed in March 2017. The filing is unaudited.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Total revenue | $1.698 billion | $1.612 billion | +5.4% |
| Operating income | $265.2 million | $249.1 million | +6.5% |
| Operating margin | 15.6% | 15.5% | Approximately +20 bps |
| Income from continuing operations | $212.5 million | $161.1 million | +31.9% |
| Diluted EPS from continuing operations | $1.89 | $1.45 | +30.3% |
| Net income | $212.5 million | $217.2 million | -2.2% |
| Net cash from operating activities | $163.0 million | $254.4 million | -$91.4 million |
Continuing-operations net margin was approximately 12.5%, compared with 10.0% in the prior-year quarter. The effective tax rate declined to 12.0% from 26.5%, primarily reflecting discrete tax items and the lower U.S. corporate tax rate under the Tax Cuts and Jobs Act. Prior-year net income included $56.1 million of discontinued-operations income, including a $100.3 million gain on sale; current-period discontinued operations produced a $32 thousand loss.
Revenue and Segment Performance
- Uniform Rental and Facility Services: Revenue increased 4.8% to $1.375 billion, including 4.9% organic growth. Gross margin declined to 45.7% from 46.1%, mainly due to higher production labor and energy costs. Income before taxes increased 5.8% to $231.5 million.
- First Aid and Safety Services: Revenue increased 9.1% to $153.4 million, including 9.0% organic growth. Gross margin improved to 47.9% from 47.5%, and income before taxes increased to $22.0 million from $19.4 million.
- All Other: Revenue, consisting primarily of fire protection and uniform direct sales, increased to $169.6 million from $159.1 million.
- Management attributed growth to new business, increased penetration of products and services at existing customers, customer retention, and acquisitions. Total revenue growth included a 0.3% acquisition benefit and a 0.1% foreign-currency headwind.
Cash Flow, Liquidity and Debt
- Operating cash flow was $163.0 million, down from $254.4 million, primarily because of working-capital changes.
- Capital expenditures were $64.5 million, including $51.7 million for Uniform Rental and Facility Services expansion. Acquisition spending was $7.6 million.
- Financing cash outflows were $112.5 million, including $139.5 million of common-stock repurchases. Cintas also received $27.5 million from stock-option exercises.
- Cash and cash equivalents declined to $118.4 million from $138.7 million at May 31, 2018. The filing reports no marketable securities at August 31, 2018.
- Debt due after one year was $2.536 billion; principal debt outstanding was approximately $2.550 billion, with an estimated fair value of $2.585 billion. No commercial paper or revolving-credit borrowings were outstanding.
- The company had a $600 million revolving credit facility and a $250 million term-loan facility, with the credit agreement maturing September 15, 2021. Cintas was in compliance with all debt covenants.
Material Changes and Unusual Items
- Cintas adopted ASC 606, Revenue from Contracts with Customers, on June 1, 2018 using the modified retrospective method. The adoption increased opening retained earnings by approximately $189.2 million and increased total assets by approximately $253.1 million, based on the disclosed implementation adjustments. The company stated that the adoption had no impact on fiscal 2019 operating cash flow.
- Reported first-quarter net income benefited by approximately $4.6 million, or $0.04 diluted EPS, from adoption of the revenue standard versus historical guidance.
- G&K integration expenses were $4.9 million, compared with $4.0 million in the prior-year quarter, and reduced diluted EPS by approximately $0.04 after tax. Remaining accrued employee termination benefits were expected to be paid over the remainder of fiscal 2019.
- During the quarter, Cintas entered into interest-rate locks with a $500 million notional value for a forecasted debt issuance. The agreements had a $4.2 million liability fair value at August 31, 2018.
- Cintas repurchased 0.4 million shares under its buyback program for $78.5 million during the quarter. Through October 5, 2018, it had repurchased an additional 0.8 million shares for $156.3 million.
Outlook, Risks and Contingencies
The filing does not provide explicit numerical revenue, earnings, margin, or cash-flow guidance. Management stated that it expects operating cash flows, debt-market access, and commercial-paper capacity to support operations, expansion, dividends, share repurchases, and other capital requirements, but future access and pricing depend partly on credit ratings.
- Key risks include G&K integration and synergy execution, labor, energy, fuel and material costs, customer losses and outsourcing trends, acquisitions, foreign exchange, tariffs, cybersecurity and systems disruptions, litigation, environmental matters, regulatory compliance, tax and labor-law changes, and competition.
- Ordinary-course legal proceedings and claims include personal injury, customer contract, environmental, and employment matters. Management did not expect these matters to have a material adverse effect, although the filing does not quantify potential exposure.
- Cintas expects adoption of the new lease standard on June 1, 2019 to materially increase reported assets and liabilities, without a material expected impact on income or cash flow.
- Unrecognized tax benefits were $28.0 million at August 31, 2018. The company continued revising its provisional Tax Act transition-tax calculation, which could change as final information becomes available.
Important Facts for Investors to Verify
- Whether revenue growth and margin performance remain sustainable after the favorable tax-rate impact and the continuing G&K integration.
- The extent to which working-capital investment continues to suppress operating cash flow.
- Future debt issuance associated with the $500 million interest-rate locks and the company’s leverage relative to EBITDA and covenant thresholds.
- Remaining G&K integration and termination costs, as well as expected realization of acquisition synergies.
- The final accounting effects of ASC 606 and the eventual balance-sheet impact of ASC 842 lease adoption.
- The final Tax Act transition-tax calculation and the outcome of ongoing domestic and foreign tax audits.
- The pace and valuation of future share repurchases relative to available liquidity and debt obligations.