Cintas Corporation: Fiscal 2018 Form 10-K Summary
Reporting period: The provided filing is Cintas Corporation’s annual report for the fiscal year ended May 31, 2018, filed July 27, 2018. The request metadata identifies “2017 Q4,” but the source is a fiscal 2018 10-K, not a fiscal 2017 quarterly filing.
Business Context
Cintas provides uniform rental and facility services, first aid and safety products and services, fire protection services, and uniform direct sales to more than one million businesses, primarily in North America. Its principal reportable segments are Uniform Rental and Facility Services and First Aid and Safety Services.
The fiscal 2018 results include a full year of operations from G&K Services, acquired on March 21, 2017 for approximately $2.1 billion. G&K operates primarily within Uniform Rental and Facility Services.
Financial Performance and Position
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Total revenue | $6.477 billion | $5.323 billion | +21.7% |
| Organic revenue growth | 7.1% | 6.7% | +0.4 percentage points |
| Operating income | $949.8 million | $773.7 million | +22.8% |
| Income before taxes | $841.0 million | $687.4 million | +22.3% |
| Net income from continuing operations | $783.9 million | $457.3 million | +71.4% |
| Diluted EPS from continuing operations | $7.03 | $4.17 | +68.6% |
| Total net income | $842.6 million | $480.7 million | +75.3% |
| Operating cash flow | $964.2 million | $763.9 million | +26.2% |
| Capital expenditures | $271.7 million | $273.3 million | -0.6% |
| Cash and cash equivalents | $138.7 million | $169.3 million | -18.0% |
| Long-term debt | $2.535 billion | $2.771 billion | -8.5% |
Total gross margin was 44.9% of revenue versus 44.7% in fiscal 2017. Income before taxes was 13.0% of revenue versus 12.9%. The effective tax rate on continuing operations declined to 6.8% from 33.5%, primarily because of the Tax Cuts and Jobs Act, including a $175.6 million deferred-tax remeasurement benefit and other tax effects. Management estimated the total net tax benefit from the Tax Act at $161.4 million.
Uniform Rental and Facility Services revenue increased 24.9% to $5.247 billion, including 17.9% acquisition-related growth and 6.7% organic growth. First Aid and Safety Services revenue increased 11.1% to $564.7 million, including 10.5% organic growth. All Other revenue was $664.8 million.
Cash Flow, Debt and Liquidity
- Operating cash flow of $964.2 million exceeded capital expenditures of $271.7 million, producing approximately $692.5 million of operating cash flow after capital expenditures before other investing and financing activities.
- Investing cash outflow was $135.7 million, compared with $2.310 billion in fiscal 2017, when the G&K acquisition was funded.
- Financing cash outflow was $864.1 million, including $550.0 million of debt repayment, $175.6 million of dividends and $127.3 million of share repurchases.
- Debt carrying value was $2.550 billion, including $2.535 billion due after one year. No commercial paper or revolving-credit borrowings were outstanding at May 31, 2018.
- The revolving credit facility had capacity of $600.0 million and supported the commercial paper program. The credit agreement matures September 15, 2021 and includes an accordion feature of up to $250.0 million.
- Contractual cash obligations totaled $3.544 billion, including $2.550 billion of debt, $196.8 million of operating leases and $797.2 million of interest payments.
- Cintas was in compliance with all debt covenants. Credit ratings at May 31, 2018 were A-2 commercial paper and BBB+ long-term debt from Standard & Poor’s, and P-2 and A3, respectively, from Moody’s; S&P later changed its outlook to positive.
Material Changes Versus Fiscal 2017
- Revenue growth accelerated because fiscal 2018 included a full year of G&K operations, compared with approximately two months in fiscal 2017.
- G&K transaction and integration expenses declined to $41.9 million from $79.2 million. Fiscal 2018 costs primarily comprised lease cancellation, facility closure and other integration expenses.
- Uniform Rental and Facility Services gross margin declined modestly to 45.0% from 45.1%, reflecting G&K’s lower margins and short-term integration inefficiencies.
- First Aid and Safety Services gross margin improved to 47.1% from 45.3%, supported by sourcing, warehouse utilization and delivery-route efficiencies.
- Selling and administrative expense increased 25.5%, partly because of a $40 million one-time cash payment to employee-partners following enactment of the Tax Act, higher G&K-related labor and amortization costs, and investment in a new enterprise resource planning system.
- Net interest expense increased to $108.8 million from $86.3 million because of acquisition-related debt.
- Cintas sold Discontinued Services for $127.8 million of proceeds and recorded a $96.4 million pretax gain. Discontinued operations contributed $58.7 million of net income in fiscal 2018.
- The annual dividend increased 21.8% to $1.62 per share, marking the 35th consecutive annual increase. Cintas repurchased approximately 0.5 million shares for $90.0 million under its buyback program.
Outlook, Risks and Unusual Items
The filing does not provide formal fiscal 2019 revenue or earnings guidance. Management’s strategy is to grow organically through increased penetration of existing customers, broader customer coverage, geographic expansion, new products and services, and selected acquisitions.
- Key execution risks include realizing expected G&K synergies, completing integration, managing facility closures and controlling acquisition-related costs.
- Other material risks include labor and healthcare cost inflation, fuel and energy prices, competition and customer insourcing, union activity, supply-chain disruption, tariffs, foreign exchange, cybersecurity and SAP implementation risks.
- Environmental liabilities and remediation obligations, including those acquired with G&K, are subject to estimation risk. Management states that reserves are adequate and that no known environmental matter is material individually, but additional obligations could arise.
- The Tax Act accounting remained provisional at May 31, 2018 and could be revised as further guidance and information become available.
- Cintas adopted the new revenue recognition standard on June 1, 2018 using the modified retrospective method and anticipated a cumulative increase to retained earnings of approximately $185 million to $215 million, primarily from deferral of certain contract costs.
- The company expected the new lease standard to materially increase reported assets and liabilities, although the filing does not provide a quantified impact.
- Management and Ernst & Young concluded that internal control over financial reporting was effective, and the auditor issued unqualified opinions on the financial statements and internal controls.
Investor Verification Checklist
- Verify that fiscal 2018 revenue and earnings growth are separated into organic growth, G&K acquisition effects, divestitures and tax benefits.
- Assess whether G&K integration inefficiencies and transaction costs have fully subsided and whether the acquired business has reached legacy Cintas margin levels.
- Reconcile reported net income and EPS to continuing operations, the $96.4 million Discontinued Services gain and the $161.4 million provisional Tax Act benefit.
- Review debt maturities, refinancing requirements and compliance with leverage and interest-coverage covenants, particularly the $900 million of debt maturities identified within the next five years.
- Evaluate recurring free cash flow after capital expenditures, dividends, share repurchases and required pension or environmental funding.
- Monitor adoption effects from revenue recognition and lease accounting standards, as well as SAP implementation costs.
- Review environmental, tax, litigation, labor and cybersecurity contingencies and the potential for reported reserves to differ from ultimate costs.