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 one million 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
On March 21, 2017, Cintas completed the acquisition of G&K for consideration of approximately $2.1 billion. G&K is a wholly-owned subsidiary of Cintas that operates within the Uniform Rental and Facility Services operating segment. To finance the G&K acquisition, Cintas used a combination of new senior notes, a term loan, other borrowings under its existing credit facility and cash on hand. G&K's results of operations are included in Cintas' consolidated financial statements as of and from the date of acquisition.
Cintas’ 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 of Fire Protection Services and its Uniform Direct Sale business, is included in All Other. 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, 2018, 2017 and 2016 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.
In fiscal 2018, Cintas sold a significant business referred to as Discontinued Services. Prior to the sale, Discontinued Services was primarily included in All Other and classified as held for sale. In fiscal 2014, Cintas completed its partnership transaction with the shareholders of Shred-it International Inc. to combine Shredding with the shredding business of Shred-it International Inc. Pursuant to the Shredding Transaction, the Shred-it Partnership was owned 42% by Cintas and 58% by the shareholders of Shred-it International Inc. Cintas' investment in 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. In accordance with the applicable accounting guidance for the disposal of long-lived assets and discontinued operations, the results of Discontinued Services, 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:
| 2018 | 2017 | 2016 | ||||||
| Revenue: | ||||||||
| Uniform Rental and Facility Services | 81.0 | % | 79.0 | % | 78.4 | % | ||
| First Aid and Safety Services | 8.7 | % | 9.5 | % | 9.6 | % | ||
| All Other | 10.3 | % | 11.5 | % | 12.0 | % | ||
| Total revenue | 100.0 | % | 100.0 | % | 100.0 | % | ||
| Cost of sales: | ||||||||
| Uniform Rental and Facility Services | 55.0 | % | 54.9 | % | 55.7 | % | ||
| First Aid and Safety Services | 52.9 | % | 54.7 | % | 57.3 | % | ||
| All Other | 57.5 | % | 58.3 | % | 58.6 | % | ||
| Total cost of sales | 55.1 | % | 55.3 | % | 56.2 | % | ||
| Gross margin: | ||||||||
| Uniform Rental and Facility Services | 45.0 | % | 45.1 | % | 44.3 | % | ||
| First Aid and Safety Services | 47.1 | % | 45.3 | % | 42.7 | % | ||
| All Other | 42.5 | % | 41.7 | % | 41.4 | % | ||
| Total gross margin | 44.9 | % | 44.7 | % | 43.8 | % | ||
| Selling and administrative expenses: | ||||||||
| Uniform Rental and Facility Services | 28.6 | % | 27.1 | % | 26.5 | % | ||
| First Aid and Safety Services | 33.7 | % | 34.9 | % | 31.9 | % | ||
| All Other | 33.9 | % | 34.5 | % | 33.1 | % | ||
| Total selling and administrative expenses | 29.6 | % | 28.7 | % | 27.8 | % | ||
| G&K Services, Inc. transaction and integration expenses | 0.6 | % | 1.5 | % | — | % | ||
| Interest expense, net | 1.7 | % | 1.6 | % | 1.3 | % | ||
| Income from continuing operations before income taxes | 13.0 | % | 12.9 | % | 14.7 | % |
Fiscal 2018 Compared to Fiscal 2017
Fiscal 2018 total revenue was $6.5 billion, an increase of 21.7% over the prior fiscal year. Revenue increased organically by 7.1% 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 14.3% due to acquisitions, primarily G&K. Revenue growth was positively impacted by 0.3% due to foreign currency exchange rate fluctuations.
Organic growth by quarter is shown in the table below.
| Organic Growth | |
| First Quarter Ended August 31, 2017 | 8.3% |
| Second Quarter Ended November 30, 2017 | 7.7% |
| Third Quarter Ended February 28, 2018 | 7.8% |
| Fourth Quarter Ended May 31, 2018 | 5.1% |
| For the Fiscal Year Ended May 31, 2018 | 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 24.9% compared to fiscal 2017. Revenue was positively impacted by 17.9% due to acquisitions, primarily G&K. The remaining increase primarily resulted from an organic growth increase in revenue of 6.7%. 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 positively impacted by 0.3% 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 9.7% compared to fiscal 2017. Revenue increased organically by 8.6% due primarily to improved sales representative productivity. Revenue growth was positively impacted by 0.1% due to foreign currency exchange rate fluctuations. Acquisitions positively impacted revenue by 1.0%.
Cost of uniform rental and facility services increased 25.1% compared to fiscal 2017. 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 2017 was due to increased Uniform Rental and Facility Services reportable operating segment sales volume from organic growth and the acquired G&K 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 increased 7.2% in fiscal 2018 compared to fiscal 2017. The increase was primarily related to the increased sales volumes in the First Aid and Safety Services reportable operating segment and All Other.
Selling and administrative expenses increased $389.4 million, or 25.5%, compared to fiscal 2017 due primarily to a one-time cash payment to employee-partners, increased labor and other employee-partner related expenses as a result of the acquisition of G&K, increased amortization expense related to intangible assets acquired as a result of the G&K acquisition and increased costs related to investments in a new enterprise resource planning system. The one-time cash payment to employee-partners was made following the enactment of The Tax Cuts and Jobs Act (the Tax Act) which was signed into legislation by the President on December 22, 2017. The one-time cash payment to employee-partners amounted to an expense of approximately $40 million, or 0.6% of total revenue. Operating income for fiscal 2018 was negatively impacted by $41.9 million, or 0.6% of total revenue, from transaction and integration expenses incurred in connection with the G&K acquisition and $79.2 million, or 1.5% of total revenue, in fiscal 2017.
Net interest expense (interest expense less interest income) was $108.8 million in fiscal 2018 compared to $86.3 million in fiscal 2017. The increase in net interest expense is primarily due to the additional debt issued to finance the G&K acquisition.
Income before income taxes was $841.0 million, an increase of $153.6 million, or 22.3%, compared to fiscal 2017. The increase in income before income taxes was primarily due to revenue growing at a faster pace than expenses.
Cintas' effective tax rate on continuing operations was 6.8% for fiscal 2018 compared to 33.5% in fiscal 2017. The decrease was due to the impact of the Tax Act. The effective tax rate in fiscal 2017 was impacted by certain discrete items (primarily the tax accounting for stock-based compensation).
Net income from continuing operations for fiscal 2018 of $783.9 million was a 71.4% increase compared to fiscal 2017.
Diluted earnings per share from continuing operations of $7.03 was a 68.6% increase compared to fiscal 2017. Diluted earnings per share from continuing operations increased primarily due to the lower effective tax rate as a result of the Tax Act, the gain on the sale of Discontinued Services and higher gross margin.
Uniform Rental and Facility Services Reportable Operating Segment
Uniform Rental and Facility Services reportable operating segment revenue increased $1,044.6 million, or 24.9%, and the cost of uniform rental and facility services increased $579.2 million, or 25.1%, as previously discussed. The reportable operating segment's fiscal 2018 gross margin was 45.0% of revenue compared to 45.1% in fiscal 2017. The slight decrease in gross margin was driven by the G&K acquisition, which had lower margins than the legacy Cintas margins. In addition, we incurred expected integration inefficiencies which impacted margins in the short-term.
Selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment increased $362.3 million in fiscal 2018 compared to fiscal 2017. Selling and administrative expense as a percent of revenue for fiscal 2018 was 28.6% compared to 27.1% in fiscal 2017. The increase in selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment was primarily related to a one-time cash payment to employee-partners, increased labor and employee-partner related expenses as a result of the G&K acquisition, increased amortization expense related to intangibles acquired as a result of the G&K acquisition and an investment in an enterprise resource planning system.
As a result of the G&K acquisition, the Uniform Rental and Facility Services reportable operating segment incurred $41.9 million of transaction and integration expenses directly related to the acquisition. The expenses incurred in fiscal 2018 consisted of lease cancellation costs, facility closure expenses and other integration related expenses.
Income before income taxes increased $140.5 million to $817.6 million for fiscal 2018 compared to fiscal 2017. Income before income taxes as a percent of revenue at 15.6% decreased 50 basis points from 16.1% in fiscal 2017. The decrease is primarily due to the increase in selling and administrative expenses as previously discussed.
First Aid and Safety Services Reportable Operating Segment
First Aid and Safety Services reportable operating segment revenue increased $56.5 million in fiscal 2018, an 11.1% increase compared to fiscal 2017. Revenue increased organically by 10.5% as a result of increased sales volume. Revenue growth was positively impacted by 0.5% due to acquisitions.
Cost of first aid and safety services increased $20.9 million, or 7.5%, in fiscal 2018, due primarily to higher sales 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 47.1% for fiscal 2018 compared to 45.3% in fiscal 2017. The increase was driven primarily by improved sourcing, leveraging of existing warehouses and optimization of delivery routes.
Selling and administrative expenses for the First Aid and Safety Services reportable operating segment increased by $13.2 million, or 7.4%, in fiscal 2018 compared to fiscal 2017. The increase was due primarily to increased labor, including a one-time cash payment to employee-partners. Selling and administrative expenses as a percent of revenue were 33.7% in fiscal 2018 compared to 34.9% in fiscal 2017. The decrease in selling and administrative expenses as a percent of revenue was due to revenue growing at a faster pace than labor and employee-partner related expenses.
Income before income taxes was $75.2 million in fiscal 2018, an increase of $22.4 million, or 42.5%, compared to fiscal 2017. Income before income taxes as a percent of revenue at 13.3%, increased from 10.4% in fiscal 2017 due to the previously discussed growth in revenue, improvement in the gross margin percentage and improvement in selling and administrative expenses as a percent of revenue.
Fiscal 2017 Compared to Fiscal 2016
Fiscal 2017 total revenue was $5.3 billion, an increase of 11.0% 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 4.8% due to acquisitions, primarily through the acquisition of G&K. Revenue growth was negatively impacted by 0.1% due to foreign currency exchange rate fluctuations and 0.4% due to one less workday in fiscal 2017 compared to fiscal 2016.
Organic growth by quarter is shown in the table below.
| Organic Growth | |
| First Quarter Ended August 31, 2016 | 6.0% |
| Second Quarter Ended November 30, 2016 | 6.0% |
| Third Quarter Ended February 28, 2017 | 6.6% |
| Fourth Quarter Ended May 31, 2017 | 8.1% |
| For the Fiscal Year Ended May 31, 2017 | 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 11.8% compared to fiscal 2016. The increase resulted from an organic growth increase in revenue of 6.9%. 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 by 0.1% due to foreign currency exchange rate fluctuations and 0.4% due to one less workday in fiscal 2017 compared to the same period in the prior fiscal year. Revenue was positively impacted by 5.4% due to acquisitions, primarily G&K.
Other revenue, consisting of revenue from the First Aid and Safety Services reportable operating segment and All Other, increased 8.2% compared to fiscal 2016. Revenue increased organically by 6.1% due primarily to improved sales representative productivity. Revenue growth was negatively impacted by 0.1% due to foreign currency exchange rate fluctuations and 0.4% due to one less workday in fiscal 2017 compared to fiscal 2016. Acquisitions positively impacted revenue by 2.6%.
Cost of uniform rental and facility services increased 10.3% compared to fiscal 2016. 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 2016 was due to increased Uniform Rental and Facility Services reportable operating segment sales volume from internal growth and the acquired G&K 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 increased 5.6% in fiscal 2017 compared to fiscal 2016. The increase was primarily related to the increased sales volumes in the First Aid and Safety Services reportable operating segment and All Other.
Selling and administrative expenses increased $195.0 million, or 14.6%, compared to fiscal 2016 due primarily to increases in labor and other employee-partner related expenses. As a result of the acquisition of G&K in fiscal 2017, the Company incurred various transaction and integration expenses, which related primarily to asset impairment charges, legal and professional fees, employee termination expenses, the write-off of excess inventory and other miscellaneous expenses. In fiscal 2017, G&K transaction and integration expenses were $79.2 million or 1.5% of total revenue.
Net interest expense (interest expense less interest income) was $86.3 million in fiscal 2017 compared to $63.6 million in fiscal 2016. The increase in net interest expense was primarily due to the additional debt issued to finance the G&K acquisition and $17.1 million of short-term debt financing fees incurred in connection with the acquisition.
Income before income taxes was $687.4 million, a decrease of $17.9 million, or 2.5%, compared to fiscal 2016. The decrease in income before income taxes was due to the G&K transaction and integration expenses and the increase in interest expense previously mentioned. These impacts were partially offset by the increase in gross margin.
Cintas' effective tax rate on continuing operations was 33.5% for fiscal 2017 compared to 36.4% in fiscal 2016. The decrease was primarily due to the adoption of Accounting Standard Update (ASU) 2016-09, "Improvements to Employee Share-Based Payment Accounting." The effective tax rate in fiscal 2017 included a benefit of $29.4 million as a result of the adoption of ASU 2016-09. This benefit was partially offset by the election to recognize forfeitures as they occur, which resulted in additional stock compensation expense of $8.3 million when compared to our historical practice of estimating forfeiture for expense purposes. The adoption of ASU 2016-09 also resulted in an increase in the effect of dilutive securities in fiscal 2017 of 0.8 million shares. For fiscal 2017, the net impact on diluted earnings per share from the adoption of ASU 2016-09 was an increase of $0.19 per share over what diluted earnings per share would have been if ASU 2016-09 was not adopted in fiscal 2017.
Net income from continuing operations for fiscal 2017 of $457.3 million was a 1.9% increase compared to fiscal 2016. Diluted earnings per share from continuing operations of $4.17 was a 3.7% increase compared to fiscal 2016. Diluted earnings per share from continuing operations increased due to the lower effective tax rate combined with the decrease in weighted average common shares outstanding. The decrease in weighted average common shares outstanding resulted from purchasing 8.8 million shares of common stock under the January 13, 2015 and August 4, 2015 share buyback programs since the beginning of fiscal 2016.
Uniform Rental and Facility Services Reportable Operating Segment
Uniform Rental and Facility Services reportable operating segment revenue increased $443.0 million, or 11.8%, and the cost of uniform rental and facility services increased $214.9 million, or 10.3%, as previously discussed. The reportable operating segment's fiscal 2017 gross margin was 45.1% of revenue compared to 44.3% in fiscal 2016. The 80 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.
Selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment increased $143.8 million in fiscal 2017 compared to fiscal 2016. Selling and administrative expense as a percent of revenue for fiscal 2017 was 27.1% compared to 26.5% in fiscal 2016. The increase in selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment was primarily related to the G&K acquisition.
As a result of the G&K acquisition, the Uniform Rental and Facility Services reportable operating segment incurred $79.2 million of transaction and integration expenses. These expenses consisted of the following: asset impairment charges of $23.3 million, legal and professional fees directly related to the acquisition of $17.4 million, employee termination expenses recognized under Accounting Standard Codification (ASC) Topic 712, "Compensation - Nonretirement Postemployment Benefits" of $31.0 million, write-off of excess inventory of $5.5 million and $2.0 million of other miscellaneous integration expenses.
Income before income taxes increased $5.0 million to $677.1 million for fiscal 2017 compared to fiscal 2016. Income before income taxes as a percent of revenue at 16.1%, decreased 180 basis points from 17.9% in fiscal 2016. The decrease is primarily due to the G&K transaction and integration expenses mentioned above.
First Aid and Safety Services Reportable Operating Segment
First Aid and Safety Services reportable operating segment revenue increased $46.5 million in fiscal 2017, a 10.1% increase compared to fiscal 2016. Revenue increased organically by 5.9% as a result of increased sales volume. Revenue growth was positively impacted by 4.6% due to acquisitions. One less workday in fiscal 2017 compared to the prior year negatively impacted growth by 0.4%.
Cost of first aid and safety services increased $13.3 million, or 5.0%, in fiscal 2017, 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 45.3% for fiscal 2017 compared to 42.7% in fiscal 2016. The increase in gross margin was due to the benefits realized as a result of the integration of ZEE Medical Inc. (ZEE). These benefits included improved delivery efficiencies and improved sourcing of goods.
Selling and administrative expenses for the First Aid and Safety Services reportable operating segment increased by $29.9 million, or 20.3%, in fiscal 2017 compared to fiscal 2016. Selling and administrative expenses as a percent of revenue were 34.9% in fiscal 2017 compared to 31.9% in fiscal 2016. The increase in selling and administrative expenses was primarily the result of the investment in selling resources to grow the acquired ZEE customer base and increases in various employee-partner related expenses.
Income before income taxes was $52.8 million in fiscal 2017, an increase of $3.3 million, or 6.6%, compared to fiscal 2016. Income before income taxes as a percent of revenue at 10.4%, decreased from 10.7% in fiscal 2016, due primarily to the investment in selling resources mentioned above.
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) | 2018 | 2017 | |||||
| Net cash provided by operating activities | $ | 964,160 | $ | 763,887 | |||
| Net cash used in investing activities | $ | (135,698 | ) | $ | (2,310,349 | ) | |
| Net cash (used in) provided by financing activities | $ | (864,140 | ) | $ | 1,578,502 | ||
| Cash and cash equivalents at the end of the period | $ | 138,724 | $ | 169,266 | |||
| Marketable securities at the end of the period | $ | — | $ | 22,219 |
Cash, cash equivalents and marketable securities as of May 31, 2018 and 2017 include $33.9 million and $125.5 million, respectively, that is located outside of the United States.
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 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 $964.2 million for fiscal 2018, which was an increase of $200.3 million compared to fiscal 2017. The increase was the result of higher net income offset by the $96.4 million gain on the sale of Discontinued Services, changes in deferred taxes as a result of the Tax Act and changes in working capital.
Net cash used in investing activities was $135.7 million in fiscal 2018 compared to $2,310.3 million in fiscal 2017. Capital expenditures were $271.7 million and $273.3 million for fiscal 2018 and fiscal 2017, respectively. Capital expenditures for fiscal 2018 included $225.7 million for the Uniform Rental and Facility Services reportable operating segment and $27.9 million for the First Aid and Safety Services reportable operating segment. Cash paid for acquisitions of businesses, net of cash acquired, was $19.3 million and $2,102.4 million for fiscal 2018 and fiscal 2017, respectively. The acquisitions in both fiscal 2018 and 2017 occurred in our Uniform Rental and Facility Services reportable operating segment, which included G&K in fiscal 2017, our First Aid and Safety Services reportable operating segment and our Fire Protection business, which is included in All Other. Net cash used in investing activities in fiscal 2018 and fiscal 2017 included proceeds of $127.8 million related to the sale of Discontinued Services and $28.3 million related to the Storage and Shredding transactions. Net cash used in investing activities for fiscal 2018 and 2017 also included net proceeds of $26.1 million and $37.3 million, respectively, from purchases and redemptions of marketable securities and investments.
Net cash used in financing activities was $864.1 million for fiscal 2018, compared to $1,578.5 million of net cash provided by financing activities in fiscal 2017. The decrease in fiscal 2018 from fiscal 2017 is primarily due to the net payment of $600.5 million of debt compared to a net issuance of $1,732.7 million of debt in fiscal 2017. To finance the G&K acquisition in fiscal 2017, Cintas issued various forms of debt, totaling $2,091.2 million, net.
On August 2, 2016, we announced that the Board of Directors authorized a $500.0 million share buyback program, which does not have an expiration date. During fiscal 2018, under the August 2, 2016 share buyback program, we purchased 0.5 million shares at an average price of $173.51 per share for a total purchase price of $90.0 million. During fiscal 2017, we purchased 0.1 million shares at an average price of $94.09 per share for a total purchase price of $3.7 million under a previously authorized share buyback program. Subsequent to May 31, 2018 through July 27, 2018, Cintas purchased 0.3 million shares at an average price of $199.15 per share for a total purchase price of $60.0 million. Under the August 2, 2016 program through July 27, 2018, Cintas has purchased a total of 0.8 million shares of Cintas common stock at an average price of $182.93 per share for a total purchase price of $150.0 million. For the fiscal year ended May 31, 2018, Cintas acquired 0.3 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 $130.30 per share for a total purchase price of $37.3 million.
On October 17, 2017, Cintas declared an annual cash dividend of $1.62 per share on outstanding common stock, a
21.8% increase over the annual dividend paid in the prior year. The dividend was paid on December 8, 2017 to shareholders of record as of November 10, 2017. This marked the 35th consecutive year that Cintas has increased its annual dividend, every year since going public in 1983.
On March 21, 2017, the Company completed the acquisition of G&K. To finance the G&K acquisition, Cintas used a combination of new senior notes, a term loan, other borrowings under its existing credit facility and cash on hand.
During the fiscal year ended May 31, 2018, Cintas paid a net total of $50.5 million of commercial paper and paid off the term loan balance of $250.0 million with cash on hand. On December 1, 2017, Cintas paid the $300.0 million aggregate principal amount of its 6.13% 10-year senior notes that matured on that date with cash on hand and $265.0 million in proceeds from the issuance of commercial paper. On June 1, 2016, Cintas paid the $250.0 million aggregate principal amount of five-year senior notes that matured on that date with cash on hand and proceeds from the issuance of commercial paper.
The following table summarizes Cintas' outstanding debt at May 31:
| (In thousands) | Interest Rate | Fiscal Year Issued | Fiscal Year Maturity | 2018 | 2017 | |||||||||
| Debt due within one year | ||||||||||||||
| Senior notes | 6.13 | % | 2008 | 2018 | $ | — | $ | 300,000 | ||||||
| Commercial paper | 1.24 | % | (1) | Various | Various | — | 50,500 | |||||||
| Current portion of term loan | 2.00 | % | (1) | 2017 | 2018 | — | 12,500 | |||||||
| Debt issuance costs | — | (100 | ) | |||||||||||
| Total debt due within one year | $ | — | $ | 362,900 | ||||||||||
| Debt due after one year | ||||||||||||||
| Senior notes | 4.30 | % | 2012 | 2022 | $ | 250,000 | $ | 250,000 | ||||||
| Senior notes | 2.90 | % | 2017 | 2022 | 650,000 | 650,000 | ||||||||
| Senior notes | 3.25 | % | 2013 | 2023 | 300,000 | 300,000 | ||||||||
| Senior notes (2) | 2.78 | % | 2013 | 2023 | 52,119 | 52,554 | ||||||||
| Senior notes (3) | 3.11 | % | 2015 | 2025 | 52,309 | 52,645 | ||||||||
| Senior notes | 3.70 | % | 2017 | 2027 | 1,000,000 | 1,000,000 | ||||||||
| Senior notes | 6.15 | % | 2007 | 2037 | 250,000 | 250,000 | ||||||||
| Long-term portion of term loan | 2.00 | % | (1) | 2017 | 2022 | — | 237,500 | |||||||
| Debt issuance costs | (19,119 | ) | (22,075 | ) | ||||||||||
| Total debt due after one year | $ | 2,535,309 | $ | 2,770,624 |
(1) Variable rate debt instrument. The rate presented is the variable borrowing rate at May 31, 2017.
(2) Cintas assumed these senior notes with the acquisition of G&K, and they were recorded at fair value. The interest rate shown above is the effective interest rate. The principal amount of these notes is $50.0 million with a stated interest rate of 3.73%.
(3) Cintas assumed these senior notes with the acquisition of G&K, and they were recorded at fair value. The interest rate shown above is the effective interest rate. The principal amount of these notes is $50.0 million with a stated interest rate of 3.88%.
The credit agreement that supports our commercial paper program was amended on September 16, 2016. The amendment increased the capacity of the revolving credit facility from $450.0 million to $600.0 million and added a $250.0 million term loan facility. The existing term loan facility was paid in full during the first quarter of fiscal 2018. The credit agreement has an accordion feature that provides Cintas the ability to request increases to the borrowing commitments under either the revolving credit facility or the term loan of up to $250.0 million in the aggregate, subject to customary conditions. The maturity date of the agreement is September 15, 2021. No commercial paper or borrowings on our revolving credit facility were outstanding at May 31, 2018. As of May 31, 2017, there was $50.5 million of commercial paper outstanding with a weighted average interest rate of 1.24% and maturity dates less than 30 days and no borrowings on our revolving credit facility.
Cintas has certain covenants related to debt agreements. These covenants limit Cintas' 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 consolidated 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. Cintas was in compliance with all of the debt covenants for all periods presented.
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, 2018, our ratings were as follows:
| Rating Agency | Outlook | Commercial Paper | Long-term Debt | |||
| Standard & Poor’s | Stable | A-2 | BBB+ | |||
| Moody’s Investors Service | Stable | P-2 | A3 | |||
On June 11, 2018, Standard & Poor's rating agency updated their ratings as follows:
| Rating Agency | Outlook | Commercial Paper | Long-term Debt | |||
| Standard & Poor’s | Positive | A-2 | BBB+ |
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.
On December 22, 2017, the United States adopted tax reform legislation commonly known as the Tax Act, which is generally effective January 1, 2018. The Tax Act includes a number of changes to U.S. tax law, including lowering the U.S. corporate income tax rate from a maximum of 35% to 21% and changing or limiting certain tax deductions. In addition, the Tax Act alters the landscape of taxation of non-U.S. operations and provides immediate deductions for certain new investments, among other provisions.
Cintas has reasonably estimated the effects of the Tax Act to be a net income tax benefit of $161.4 million for fiscal 2018. The significant components of this income tax benefit include (i) the remeasurement of net deferred tax liabilities at the lower enacted U.S. corporate tax rate, which resulted in a net $175.6 million decrease in income tax expense; (ii) a $4.4 million net tax expense comprised of foreign withholding taxes related to certain non-U.S. earnings subject to repatriation; and (iii) $9.8 million in transition tax related to certain non-U.S. earnings subject to repatriation that were previously tax deferred.
The overall net impact of the Tax Act resulted in a net decrease in Cintas’ effective tax rates in fiscal 2018, and we anticipate the net impact of the Tax Act on future periods to also be a net decrease in our effective tax rates. While the reduction in the U.S. federal tax rate from 35% to 21% in fiscal 2018 and beyond will result in lower income tax expense, other elements of the Tax Act will partially offset this reduction. Elements of the Tax Act that will cause an increase in future income tax expense include:
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The Tax Act expands the limitation on the deduction of certain executive compensation. This expansion is subject to transition rules that provide relief for previously awarded compensation. We estimate that this deduction limitation will adversely impact our effective rate in future periods.
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The Tax Act limits certain entertainment deductions.
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The Tax Act eliminates the Section 199 deduction.
The estimated impacts of the Tax Act recorded during fiscal 2018 as well as the forward-looking estimates are provisional in nature, and Cintas will continue to assess the impact of the Tax Act and provide additional information and record adjustments through the income tax provision in the relevant period as amounts are known and reasonably estimable during the measurement period. Accordingly, the impact of the Tax Act may differ from our provisional estimates due to, among other factors, information currently not available, changes in interpretations and the issuance of additional guidance, as well as changes in assumptions Cintas has made, including actions Cintas may take in fiscal 2019 as a result of the Tax Act.
Contractual Obligations
| Payments Due by Period | |||||||||||||||||||
| (In thousands) | Total | One year or less | Two to three years | Four to five years | After five years | ||||||||||||||
| Debt (1) | $ | 2,550,000 | $ | — | $ | — | $ | 1,250,000 | $ | 1,300,000 | |||||||||
| Operating leases (2) | 196,774 | 49,313 | 75,336 | 44,409 | 27,716 | ||||||||||||||
| Interest payments (3) | 797,243 | 95,530 | 191,060 | 151,210 | 359,443 | ||||||||||||||
| Unconditional purchase obligations | — | — | — | — | — | ||||||||||||||
| Total contractual cash obligations | $ | 3,544,017 | $ | 144,843 | $ | 266,396 | $ | 1,445,619 | $ | 1,687,159 |
| (1) | See Note 6 entitled Debt and Derivatives of "Notes to Consolidated Financial Statements" for a detailed presentation of Cintas' 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, 2018, Cintas did not have commercial paper outstanding, and therefore did not have any variable rate debt. |
Cintas also makes payments to defined contribution plans and may make payments to defined benefit plans to satisfy minimum funding requirements. The amount of contributions made to the defined contribution plans are at the discretion of the Board of Directors of Cintas. Future contributions to the defined contribution plans are expected to be $62.5 million in the next year, $134.5 million in the next two to three years and $148.3 million in the next four to five years. Future contributions to the defined benefit plans are expected to be $4.3 million in the next year, $5.6 million in the next two to three years and $5.6 million in the next four to five years.
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) | $ | 599,876 | $ | — | $ | — | $ | 599,876 | $ | — | |||||||||
| Standby letters of credit and surety bonds (2) | 143,035 | 143,035 | — | — | — | ||||||||||||||
| Total other commitments | $ | 742,911 | $ | 143,035 | $ | — | $ | 599,876 | $ | — |
| (1) | Back-up facility for the commercial paper program (reference Note 6 entitled Debt and Derivatives of "Notes to Consolidated Financial Statements" for further discussion). |
| (2) | These standby letters of credit and surety bonds support certain outstanding debt (reference Note 6 entitled 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 April 2014, the Financial Accounting Standards Board (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. Cintas adopted ASU 2014-08 during the quarter ended August 31, 2015 and applied the amended accounting guidance to Shred-it and all subsequent transactions, as appropriate.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," to clarify revenue recognition principles. The standard applies one comprehensive revenue recognition model across all contracts, entities and sectors. The core principal of the new standard is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard includes cost guidance, whereby all direct and incremental costs to obtain or fulfill a contract will be capitalized and amortized over the corresponding period of benefit, determined on a contract by contract basis. This guidance is also 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. Cintas adopted this standard on June 1, 2018. The largest impacts to the Company’s financial statements will result from the new qualitative and quantitative disclosures that will be required upon adoption of the new standard. There will be two implementation adjustments upon adoption of the new standard related to the capitalization of certain direct and incremental contract costs and the timing of revenue recognition for certain contracts with customers that create an asset with no alternative use to the Company. The Company will apply the modified retrospective adoption alternative for this standard and anticipates recognizing a cumulative effect adjustment in the range of approximately $185.0 million to $215.0 million of an increase to retained earnings as of June 1, 2018, which primarily reflects the deferral of contract costs.
In April 2015, the FASB issued ASU 2015-03, "Interest - Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs." ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the consolidated condensed balance sheet as a direct deduction from the carrying amount of
that debt liability, consistent with debt discounts. This guidance is effective for annual and interim periods beginning after December 15, 2015. The guidance is applied retrospectively and early adoption is permitted. Cintas adopted ASU 2015-03 during the quarter ended August 31, 2016 and has applied this amended accounting guidance to its long-term debt and other assets for all periods presented.
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. The Company currently expects the adoption of this standard to result in a material increase to the assets and liabilities on the consolidated balance sheets.
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 requires excess tax benefits for share-based payments to 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. Cintas adopted ASU 2016-09 during the quarter ended August 31, 2016 and elected to make an accounting policy change to recognize forfeitures as they occur. The adoption impact on the consolidated balance sheet was a cumulative-effect adjustment of $26.7 million, increasing opening retained earnings and decreasing paid-in capital.
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates the two-step process that required identification of potential impairment and a separate measure of the actual impairment. Goodwill impairment charges, if any, would be determined by the difference between a reporting unit's carrying value and its fair value (impairment loss is limited to the carrying value). This standard is effective for annual or any interim goodwill impairment tests beginning after December 15, 2019. The adoption of this standard is not expected to have a material impact on the consolidated financial statements.
In March 2017, the FASB issued ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Costs.” ASU 2017-07 continues to require the service component of pension and other postretirement benefit costs to be presented in the same line item as other employee compensation costs on the consolidated statement of income and changes the presentation of other components of net benefit cost so that these items will be presented outside of operating income within the consolidated statements of income. Cintas retrospectively adopted ASU 2017-07 on June 1, 2017. The adoption of this standard did not have a material effect on the consolidated financial statements.
In February 2018, the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." ASU 2018-02 allows entities to elect to reclassify the income tax effects of the Tax Act on items within accumulated other comprehensive income to retained earnings and requires additional related disclosures. This standard is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Cintas is currently evaluating the impact that ASU 2018-02 will have on its consolidated condensed 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 U.S. 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.
Inventories
Inventories are valued at the lower of cost (first-in, first-out) or net realizable value. 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 net realizable value. 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. Uniforms acquired in the G&K acquisition were amortized over 12 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 Cintas 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. As a result of the identification of certain G&K plants and branches for future closure, an indicator of potential impairment was identified. Cintas recognized an impairment loss of $23.3 million during the fiscal year ended May 31, 2017, based on the excess of the carrying amount of asset over their respective fair values. The undiscounted cash flows were estimated, using Level 2 inputs based on both the cost and market approaches, at the lowest discernible level, which is at the location level. Cintas did not identify any indicators of impairment for the fiscal years ended May 31, 2018 and 2016.
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. Cintas has identified four reporting units for purposes of evaluating goodwill impairment: Uniform Rental and Facility Services, First Aid and Safety Services, and two reporting units within All Other. 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, 2018, 2017 or 2016. Cintas will continue to perform impairment tests as of March 1 in future years and 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. The G&K service contract asset is being amortized over a period of 15 years, which represents the estimated life of the economic benefit and the asset amortization is based on the annual economic value of the underlying asset which generally decreases over the 15-year term. 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, 2018, 2017 or 2016.
Business Combinations
Accounting for acquisitions requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of income. See Note 9 entitled Acquisitions and Divestitures of the "Notes to Consolidated Financial Statements" for a discussion of the G&K acquisition.
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. Generally, 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. U.S. 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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