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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2011

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

COMMISSION FILE NUMBER 1-13495

 

MAC-GRAY CORPORATION

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

04-3361982

(State or other jurisdiction incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

404 WYMAN STREET, SUITE 400

 

 

WALTHAM, MASSACHUSETTS

 

02451-1212

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (781) 487-7600

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large Accelerated Filer o

 

Accelerated Filer x

 

 

 

Non-Accelerated Filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

As of November 1, 2011, 14,306,090 shares of common stock of the registrant, par value $.01 per share, were outstanding.

 

 

 



Table of Contents

 

INDEX

 

PART I

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at December 31, 2010 and September 30, 2011

3

 

 

 

 

 

 

Condensed Consolidated Income Statements for the Three and Nine Months Ended September 30, 2010 and 2011

4

 

 

 

 

 

 

Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2011

5

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2010 and 2011

6

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

29

 

 

 

 

 

Item 4.

Controls and Procedures

31

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1A.

Risk Factors

31

 

 

 

 

 

Item 6.

Exhibits

32

 

 

 

 

 

Signature

 

33

 

2



Table of Contents

 

Item 1.           Financial Statements

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands, except share data)

 

 

 

December 31,

 

September 30,

 

 

 

2010

 

2011

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

13,013

 

$

12,934

 

Trade receivables, net of allowance for doubtful accounts

 

6,105

 

6,343

 

Inventory of finished goods, net

 

1,580

 

1,930

 

Deferred income taxes

 

963

 

963

 

Prepaid facilities management rent and other current assets

 

9,916

 

9,980

 

Total current assets

 

31,577

 

32,150

 

Property, plant and equipment, net

 

128,068

 

128,857

 

Goodwill

 

58,608

 

58,281

 

Intangible assets, net

 

195,144

 

185,378

 

Prepaid facilities management rent and other assets

 

10,686

 

10,918

 

Total assets

 

$

424,083

 

$

415,584

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt and capital lease obligations

 

$

4,511

 

$

4,238

 

Trade accounts payable

 

8,673

 

7,304

 

Accrued facilities management rent

 

21,084

 

20,613

 

Accrued expenses and other current liabilities

 

15,998

 

16,930

 

Total current liabilities

 

50,266

 

49,085

 

Long-term debt and capital lease obligations

 

221,425

 

208,994

 

Deferred income taxes

 

41,823

 

41,835

 

Other liabilities

 

2,518

 

2,438

 

Total liabilities

 

316,032

 

302,352

 

 

 

 

 

 

 

Commitments and contingencies (Note 5)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock ($.01 par value, 5 million shares authorized, no shares issued or outstanding)

 

 

 

Common stock ($.01 par value, 30 million shares authorized, 14,026,919 issued and 14,026,743 outstanding at December 31, 2010, and 14,289,887 issued and outstanding at September 30, 2011)

 

140

 

143

 

Additional paid in capital

 

81,296

 

85,161

 

Accumulated other comprehensive loss

 

(1,563

)

(1,023

)

Retained earnings

 

28,180

 

28,951

 

 

 

108,053

 

113,232

 

Less common stock in treasury, at cost (176 shares at December 31, 2010)

 

(2

)

 

Total stockholders’ equity

 

108,051

 

113,232

 

Total liabilities and stockholders’ equity

 

$

424,083

 

$

415,584

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3



Table of Contents

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)

(In thousands, except per share data)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2011

 

2010

 

2011

 

Revenue:

 

 

 

 

 

 

 

 

 

Laundry facilities management revenue

 

$

73,882

 

$

74,287

 

$

226,417

 

$

228,435

 

Commercial laundry equipment sales

 

4,359

 

4,205

 

11,868

 

10,939

 

Total revenue from continuing operations

 

78,241

 

78,492

 

238,285

 

239,374

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Cost of laundry facilities management revenue

 

50,839

 

52,004

 

154,833

 

157,560

 

Depreciation and amortization

 

11,687

 

10,568

 

34,262

 

32,512

 

Cost of commercial laundry equipment sales

 

3,357

 

3,144

 

9,468

 

8,722

 

Total cost of revenue

 

65,883

 

65,716

 

198,563

 

198,794

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

12,358

 

12,776

 

39,722

 

40,580

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

General and administration

 

4,499

 

4,759

 

13,632

 

14,190

 

Sales and marketing

 

3,483

 

3,023

 

10,184

 

10,186

 

Depreciation and amortization

 

378

 

425

 

1,163

 

1,221

 

Gain on sale of assets, net

 

(95

)

(13

)

(208

)

(170

)

Incremental costs of proxy contests

 

 

 

235

 

269

 

Total operating expenses

 

8,265

 

8,194

 

25,006

 

25,696

 

Income from continuing operations

 

4,093

 

4,582

 

14,716

 

14,884

 

Interest expense, including the change in the fair value of non-hedged derivative instruments

 

2,690

 

3,463

 

8,652

 

9,506

 

Income before provision for income taxes from continuing operations

 

1,403

 

1,119

 

6,064

 

5,378

 

Provision for income taxes

 

577

 

515

 

2,537

 

2,204

 

Income from continuing operations, net

 

826

 

604

 

3,527

 

3,174

 

Income from discontinued operations, net

 

 

 

44

 

 

Loss from disposal of discontinued operations, net of taxes of $384

 

 

 

(294

)

 

Net income

 

$

826

 

$

604

 

$

3,277

 

$

3,174

 

Earnings per share — basic - continuing operations

 

$

0.06

 

$

0.04

 

$

0.26

 

$

0.22

 

Earnings per share — diluted - continuing operations

 

$

0.06

 

$

0.04

 

$

0.25

 

$

0.21

 

Loss per share — basic - discontinued operations

 

$

 

$

 

$

(0.02

)

$

 

Loss per share — diluted - discontinued operations

 

$

 

$

 

$

(0.02

)

$

 

Earnings per share — basic

 

$

0.06

 

$

0.04

 

$

0.24

 

$

0.22

 

Earnings per share — diluted

 

$

0.06

 

$

0.04

 

$

0.23

 

$

0.21

 

Weighted average common shares outstanding - basic

 

13,807

 

14,286

 

13,759

 

14,207

 

Weighted average common shares outstanding - diluted

 

14,402

 

15,000

 

14,297

 

14,953

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4



Table of Contents

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

(In thousands, except share data)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Additional

 

Other

 

 

 

 

 

Treasury Stock

 

 

 

 

 

Number

 

 

 

Paid In

 

Comprehensive

 

Comprehensive

 

Retained

 

Number

 

 

 

 

 

 

 

of shares

 

Value

 

Capital

 

Income (Loss)

 

Income

 

Earnings

 

of shares

 

Cost

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2010

 

14,026,919

 

$

140

 

$

81,296

 

$

(1,563

)

 

 

$

28,180

 

176

 

$

(2

)

$

108,051

 

Net income

 

 

 

 

 

$

3,174

 

3,174

 

 

 

$

3,174

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on derivative instrument, net of tax of $340 (Note 3)

 

 

 

 

540

 

540

 

 

 

 

$

540

 

Comprehensive income

 

 

 

 

 

 

 

 

 

$

3,714

 

 

 

 

 

 

 

 

 

Options Exercised

 

92,726

 

2

 

735

 

 

 

 

 

(176

)

2

 

$

739

 

Stock issuance - Employee

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock Purchase Plan

 

24,487

 

 

316

 

 

 

 

 

 

 

$

316

 

Stock compensation expense

 

 

 

2,290

 

 

 

 

 

 

 

$

2,290

 

Dividends paid, $.165 per share

 

 

 

49

 

 

 

 

(2,401

)

 

 

$

(2,352

)

Stock grants

 

145,755

 

1

 

475

 

 

 

 

(2

)

 

 

$

474

 

Balance, September 30, 2011

 

14,289,887

 

$

143

 

$

85,161

 

$

(1,023

)

 

 

$

28,951

 

 

$

 

$

113,232

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5



Table of Contents

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

 

 

 

Nine months ended
September 30,

 

 

 

2010

 

2011

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

3,277

 

$

3,174

 

Adjustments to reconcile net income to net cash flows provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

35,425

 

33,733

 

Increase (decrease) in allowance for doubtful accounts and lease reserves

 

65

 

(3

)

(Gain) on disposition of assets

 

(208

)

(170

)

Loss from disposal of discontinued operations

 

294

 

 

Stock grants

 

172

 

475

 

Change in fair value of interest rate derivatives

 

(2,812

)

(487

)

Change in fair value of fuel collar derivatives

 

 

133

 

Proceeds from termination of derivative instrument

 

 

2,542

 

Deferred income taxes

 

(42

)

138

 

Non-cash stock compensation

 

1,950

 

2,290

 

(Increase) in accounts receivable

 

(1,507

)

(235

)

(Increase) in inventory

 

(162

)

(350

)

Decrease (increase) in prepaid facilities management rent and other assets

 

1,728

 

(5,335

)

Increase (decrease) in accounts payable, accrued facilities management rent, accrued expenses and other liabilities

 

(3,271

)

196

 

Net cash flows used in operating activities from discontinued operations

 

(44

)

 

Net cash flows provided by operating activities

 

34,865

 

36,101

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(16,750

)

(22,026

)

Proceeds from sale of assets

 

461

 

231

 

Proceeds from disposal of discontinued operations

 

8,274

 

 

Net cash flows used in investing activities

 

(8,015

)

(21,795

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments on capital lease obligations

 

(1,392

)

(1,258

)

Payments on secured revolving credit facility

 

(110,500

)

(100,231

)

Borrowings on secured revolving credit facility

 

88,430

 

90,651

 

Payments on secured term credit facility

 

(2,500

)

(2,250

)

Proceeds from exercise of stock options

 

333

 

739

 

Proceeds from issuance of common stock

 

246

 

316

 

Cash dividend paid

 

(2,063

)

(2,352

)

Net cash flows used to pay down term facility from discontinued operations

 

(8,000

)

 

Net cash flows used in financing activities

 

(35,446

)

(14,385

)

 

 

 

 

 

 

(Decrease) in cash and cash equivalents

 

(8,596

)

(79

)

Cash and cash equivalents, beginning of period

 

21,599

 

13,013

 

Cash and cash equivalents, end of period

 

$

13,003

 

$

12,934

 

 

Supplemental disclosure of non-cash investing and financing activities: during the nine months ended September 30, 2010 and 2011, the Company acquired various vehicles under capital lease agreements totaling $1,842 and $384, respectively.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

 

1.  Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The unaudited interim condensed consolidated financial statements do not include all information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of the management of Mac-Gray Corporation (the “Company” or “Mac-Gray,”) the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal, recurring adjustments), which are necessary to present fairly the Company’s financial position, the results of its operations, and its cash flows. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s 2010 audited consolidated financial statements filed with the Securities and Exchange Commission in its Annual Report on Form 10-K for the year ended December 31, 2010. The results for interim periods are not necessarily indicative of the results to be expected for the full year.

 

The Company generates the majority of its revenue from card and coin-operated laundry equipment located in 43 states throughout the United States, as well as the District of Columbia. The Company’s principal customer base is the multi-unit housing market, which consists of apartments, condominium units, colleges and universities. The Company also sells and services commercial laundry equipment to commercial laundromats, multi-housing properties and institutions. The majority of the Company’s purchases of laundry equipment are from one supplier.

 

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. On February 5, 2010, the Company sold its MicroFridge® (Intirion Corporation) business to Danby Products. The operations and cash flows of this business have been eliminated from the ongoing operations of the Company as a result of this disposal transaction. Since the Company will not have any significant continuing involvement in the operations of this business, the Company has accounted for this business as a discontinued operation.  All prior period financial information has been restated to reflect Intirion Corporation as a discontinued operation.

 

2.   Long-Term Debt

 

The Company has a senior secured credit agreement (the “Secured Credit Agreement”) pursuant to which the Company may borrow up to $149,500 in the aggregate, including $19,500 pursuant to a Term Loan and up to $130,000 pursuant to a Revolver.  The Term Loan requires quarterly principal payments of $750 at the end of each calendar quarter through December 31, 2012, with the remaining principal balance of $15,750 due on April 1, 2013. The Secured Credit Agreement also provides for Bank of America, N. A. to make swingline loans to us of up to $10,000 (the “Swingline Loans”) and any Swingline Loans will reduce the borrowings available under the Revolver.  Subject to certain terms and conditions contained therein, the Secured Credit Agreement gives the Company the option to establish additional term and/or revolving credit facilities thereunder, provided that the aggregate commitments under the Secured Credit Agreement cannot exceed $220,000.

 

Borrowings outstanding under the Secured Credit Agreement bear interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate (adjusted for statutory reserves) plus an applicable percentage, ranging from 2.00% to 2.50% per annum (currently 2.00%), determined by reference to the Company’s senior secured leverage ratio, and (ii) in the case of base rate loans and Swingline Loans, the higher of (a) the federal funds rate plus 0.5% or (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” in each case, plus an applicable percentage, ranging from 1.00% to 1.50% per annum (currently 1.00%), determined by reference to the Company’s  senior secured leverage ratio.

 

7



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

2.   Long-Term Debt (continued)

 

The obligations under the Secured Credit Agreement are guaranteed by the Company’s subsidiaries and collateralized by (i) a pledge of 100% of the ownership interests in the subsidiaries, and (ii) a first-priority security interest in substantially all our tangible and intangible assets.

 

Under the Secured Credit Agreement, the Company is subject to customary lending covenants, including restrictions pertaining to, among other things: (i) the incurrence of additional indebtedness, (ii) limitations on liens, (iii) making distributions, dividends and other payments, (iv) the making of certain investments and loans, (v) mergers, consolidations and acquisitions, (vi) dispositions of assets, (vii) the maintenance of a maximum total leverage ratio of not greater than 4.25 to 1.00, a maximum senior secured leverage ratio of not greater than 2.50 to 1.00, and a minimum consolidated cash flow coverage ratio of not less than 1.20 to 1.00, (viii) transactions with affiliates, and (ix) changes to governing documents and subordinate debt documents, in each case subject to baskets, exceptions and thresholds.  The Company was in compliance with these and all other financial covenants at September 30, 2011.

 

The Secured Credit Agreement provides for customary events of default with, in some cases, corresponding grace periods, including (i) failure to pay any principal or interest when due, (ii) failure to comply with covenants, (iii) any representation or warranty made by us proving to be incorrect in any material respect, (iv) payment defaults relating to, or acceleration of, other material indebtedness, (v) certain bankruptcy, insolvency or receivership events affecting us, (vi) a change in our control, (vii) the Company or its subsidiaries becoming subject to certain material judgments, claims or liabilities, or (viii) a material defect in the lenders’ lien against the collateral securing the obligations under the Secured Credit Agreement.

 

In the event of an event of default, the Administrative Agent may, and at the request of the requisite number of lenders under the Secured Credit Agreement must, terminate the lenders’ commitments to make loans under the Secured Credit Agreement and declare all obligations under the Secured Credit Agreement immediately due and payable.  For certain events of default related to bankruptcy, insolvency and receivership, the commitments of the lenders will be automatically terminated and all outstanding obligations of the Company under the Secured Credit Agreement will become immediately due and payable.

 

The Company pays a commitment fee equal to a percentage of the actual daily unused portion of the Secured Revolver under the Secured Credit Agreement.  This percentage, currently 0.300% per annum, is determined quarterly by reference to the senior secured leverage ratio and will range between 0.300% per annum and 0.500% per annum.

 

As of September 30, 2011, there was $40,773 outstanding under the Revolver, $19,500 outstanding under the Term Loan and $1,380 in outstanding letters of credit. The available balance under the Revolver was $87,847 at September 30, 2011. The average interest rates on the borrowings outstanding under the Secured Credit Agreement at September 30, 2010 and 2011 were 7.03% and 5.71%, respectively, including the applicable spread paid to the banks and the effect of the interest rate swap agreements tied to the debt (see Note 3 for discussion on Fair Value Measurements).

 

On August 16, 2005, the Company issued senior unsecured notes in the amount of $150,000. These notes bear interest at 7.625% payable semi-annually each February and August. A portion of the senior notes are tied to an interest rate swap agreement (see Note 3 for discussion on Fair Value Measurements). After taking the swap agreement into effect, the average interest rates on the senior notes at September 30, 2010 and 2011 were 5.86% and 7.63%, respectively. The maturity date of the notes is August 15, 2015. The proceeds from the senior notes, less financing costs, were used to pay down senior bank debt.  Since the senior notes are not widely traded, the market value of these notes approximates book value at September 30, 2011.

 

The Company has the option to redeem all or a portion of the senior notes at the redemption prices (expressed in percentages of principal amount on the redemption date), plus accrued interest to the redemption date, if redeemed, during the 12-month period commencing on August 15 of the years set forth below:

 

8



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

2.   Long-Term Debt (continued)

 

 

 

Redemption

 

Period

 

Price

 

2011

 

102.542

%

2012

 

101.271

%

2013 and thereafter

 

100.000

%

 

On September 22, 2011 the Company issued a notice to redeem $50,000 of its senior notes effective October 21, 2011. On the effective date, the Company redeemed $50,000 of its senior notes by utilizing $51,271 of availability under its revolving credit facility.  As the revolving credit facility has a maturity date greater than one year and is presented within long term debt at September 30, 2011, the company has classified the $50,000 of the senior notes as a long term liability at September 30, 2011.

 

The terms of the senior notes include customary covenants, including, but not limited to, restrictions pertaining to: (i) incurrence of additional indebtedness and issuance of preferred stock, (ii) payment of dividends on or making of distributions in respect of capital stock or making certain other restricted payments or investments, (iii) entering into agreements that restrict distributions from restricted subsidiaries, (iv) sale or other disposition of assets, including capital stock of restricted subsidiaries, (v) transactions with affiliates, (vi) incurrence of liens, (vii) sale/leaseback transactions, and (viii) merger, consolidation or sale of substantially all of our assets, in each case subject to numerous baskets, exceptions and thresholds. The Company was in compliance with these and all other financial covenants at September 30, 2011.

 

The terms of the senior notes provide for customary events of default, including, but not limited to: (i) failure to pay any principal or interest when due, (ii) failure to comply with covenants and limitations, (iii) certain insolvency or receivership events affecting us or any of our subsidiaries, and (iv) unsatisfied material judgments, claims or liabilities against us. There were no events of default under the senior notes at September 30, 2011.

 

Capital lease obligations on the Company’s fleet of vehicles totaled $3,833 and $2,959 at December 31, 2010 and September 30, 2011, respectively.

 

Required payments under the Company’s long-term debt and capital lease obligations are as follows:

 

 

 

Amount

 

2011 (three months)

 

$

1,079

(1)

2012

 

4,182

 

2013

 

107,444

 

2014

 

495

 

2015

 

100,032

 

Thereafter

 

 

 

 

$

213,232

 

 


(1)          The redemption of the $50,000 in senior notes discussed above is not reflected in the 2011 payments amount as the $50,000 was borrowed from our revolving credit facility and is due at maturity on April 1, 2013.

 

The Company historically has not needed sources of financing other than its internally generated cash flow and revolving credit facilities to fund its working capital, capital expenditures, and smaller acquisitions. As a result, the Company anticipates that its cash flow from operations and revolving credit facilities will be sufficient to meet its anticipated cash requirements for at least the next twelve months.

 

9



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

3.   Fair Value Measurements

 

The Company has adopted accounting guidance regarding fair value measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

Level 1:  Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

Level 2:  Inputs, other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

Level 3:  Unobservable inputs that reflect the reporting entity’s own assumptions.

 

The following table summarizes the basis used to measure certain financial assets and financial liabilities at fair value on a recurring basis in the balance sheet:

 

 

 

Balance at
September 30,
2011

 

Quoted
Prices In
Active
Markets
for
Identical
Items
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Interest rate swap derivative financial instruments (included in accrued expenses and other current liabilities)

 

$

1,792

 

$

 

$

1,792

 

$

 

 

 

 

 

 

 

 

 

 

 

Interest rate swap derivative financial instruments (included in other liabilities)

 

$

800

 

$

 

$

800

 

$

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives (included in accrued expenses and other current liabilities)

 

$

78

 

$

 

$

 

$

78

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives (included in other liabilities)

 

$

55

 

$

 

$

 

$

55

 

 

10



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

3.   Fair Value Measurements (continued)

 

The Company has entered into standard International Swaps and Derivatives Association (“ISDA”) interest rate swap agreements (“Swap Agreements”) to manage the interest rate associated with its debt. The interest rate Swap Agreements effectively convert a portion of the Company’s variable rate debt to a long-term fixed rate. Under these agreements the Company receives a variable rate of LIBOR plus a markup and pays a fixed rate.

 

The Company also entered into an interest rate swap agreement to manage the interest rate associated with its senior unsecured notes. This interest rate swap agreement converted a portion ($100 million) of our fixed rate senior unsecured notes to a variable rate. Under this interest rate swap agreement the Company received a fixed rate of 7.625% and paid a variable rate of LIBOR plus the applicable margin charged by the banks. This interest rate swap agreement had an associated call feature that allowed the counterparty to terminate this agreement at their option. On July 22, 2011 the counterparty exercised their right to terminate this agreement effective August 21, 2011. The Company received proceeds from this termination in the amount of $2,542.  This amount is reflected in the operating section of the Cash Flow Statement.

 

In December 2010 the Company entered into a fuel commodity derivative to manage the fuel cost of its fleet of vehicles. The derivative is effective April 1, 2011 and expires December 31, 2011.  The derivative has a monthly notional amount of 80 thousand gallons from April 1, 2011 through December 31, 2011 for a total notional amount of 720 thousand gallons.  The Company has a put price of $3.015 per gallon and a strike price of $3.50 per gallon. On September 23, 2011 the Company entered into additional fuel commodity derivative. This derivative has a monthly notional amount of 85 thousand gallons and is effective from January 1, 2012 through December 31, 2012 for a total notional amount of 1.02 million gallons. The Company has a put price of $3.205 per gallon and a strike price of $3.70 per gallon. The Company recognized a non-cash unrealized loss of $255 and $133 for the three and nine months ended September 30, 2011, respectively, on these fuel commodity derivatives as a result of the change in the fair value.

 

The fair value of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and are considered a Level 2 item. The fuel commodity derivatives are based on market assumptions and a quoted price from the counter party and is considered a Level 3 item.

 

The fuel commodity derivative activity for the nine months ended September 30, 2011 is as follows:

 

Balance, December 31, 2010

 

$

 

Realized gains

 

103

 

Unrealized losses

 

(133

)

Settlements

 

(103

)

Balance, September 30, 2011

 

$

(133

)

 

One of the Company’s interest rate Swap Agreements qualifies as a cash flow hedge while the others do not. The change in the fair value of the interest rate Swap Agreements that do not qualify for hedge accounting treatment is recognized in the income statement in the period in which the change occurs. The effective portion of the interest rate Swap Agreement that qualifies for hedge accounting is included in Other Comprehensive Loss in the period in which the change occurs, while the ineffective portion, if any, is recognized in income in the period in which the change occurs.

 

During the first quarter of 2010 the Company no longer qualified for hedge accounting treatment for one of its interest rate swap agreements.  Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost must be reclassified as an earnings charge through the maturity date of the derivative.  This charge amounted to $100 and $371 for the three and nine months ended September 30, 2011, respectively, compared to $199 and $1,083 for the three and nine months ended September 30, 2010,

 

11



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

Fair Value Measurements (continued)

 

respectively. The remaining balance of $230 associated with this interest rate swap and included in Accumulated Other Comprehensive Loss will be charged against income through the maturity date of the interest rate swap agreement on April 1, 2013.

 

The table below outlines the details of each remaining interest rate Swap Agreement:

 

 

 

 

 

Notional

 

Notional

 

 

 

 

 

 

 

Original

 

Amount

 

Amount

 

 

 

 

 

Date of

 

Notional

 

Fixed/

 

September 30,

 

Expiration

 

Fixed

 

Origin

 

Amount

 

Amortizing

 

2011

 

Date

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

May 8, 2008

 

$

45,000

 

Amortizing

 

$

30,000

 

Apr 1, 2013

 

3.78

%

May 8, 2008

 

$

40,000

 

Amortizing

 

$

26,000

 

Apr 1, 2013

 

3.78

%

 

In accordance with the interest rate Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate. With regard to the Company’s floating to fixed rate interest rate swap agreements, if interest expense, as calculated, is greater based on the 90-day LIBOR, the financial institution pays the difference to the Company.  If interest expense, as calculated, is greater based on the fixed rate, the Company pays the difference to the financial institution. With regard to the Company’s fixed to floating rate interest rate swap agreement, if interest expense, as calculated, is greater based on the 90-day LIBOR, the Company pays the difference to the financial institution.  If interest expense, as calculated, is greater based on the fixed rate, the financial institution pays the difference to the Company.

 

Depending on fluctuations in the LIBOR, the Company’s interest rate exposure and its related impact on interest expense and net cash flow may increase or decrease. The counterparty to the interest rate Swap Agreements expose the Company to credit loss in the event of non-performance; however, nonperformance is not anticipated.

 

The tables below display the impact the Company’s derivative instruments had on the Condensed Consolidated Balance Sheets as of December 31, 2010 and September 30, 2011 and the Condensed Consolidated Income Statements for the three months ended September 30, 2010 and 2011.

 

12



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

3.   Fair Value Measurements (continued)

 

Fair Values of Derivative Instruments

 

 

 

Liability Derivatives

 

 

 

December 31, 2010

 

September 30, 2011

 

 

 

Balance Sheet
Location

 

Fair Value

 

Balance Sheet
Location

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Accrued expenses

 

$

(1,015

)

Accrued expenses

 

$

(987

)

Interest rate contracts

 

Other liabilites

 

(931

)

Other liabilites

 

(449

)

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Accrued expenses

 

532

 

Accrued expenses

 

(805

)

Interest rate contracts

 

Other liabilites

 

(4

)

Other liabilities

 

(351

)

Fuel commodity derivatives

 

Accrued expenses

 

 

Accrued expenses

 

(78

)

Fuel commodity derivatives

 

Other liabilites

 

 

Other liabilites

 

(55

)

 

 

 

 

 

 

 

 

 

 

Total derivatives

 

 

 

$

(1,418

)

 

 

$

(2,725

)

 

13



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

3.   Fair Value Measurements (continued)

 

 

 

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

 

 

 

 

 

 

 

for the three months ended September 30, 2010 and 2011

 

 

 

 

 

Derivatives in
Net Investment
Hedging
Relationships

 

Amount of Gain or (Loss)
Recognized in OCI on
Derivative (Effective
Portion)

 

Location of Gain or
(Loss)Reclassified
from Accumulated
OCI into Income
(Effective Portion)

 

Amount of Gain (Loss)
Reclassified from
Accumulated OCI into
Income (Effective Portion)

 

Derivatives
Not
Designated as
Hedging
Instruments

 

Location of
Gain or
(Loss)
Recognized
in Income on
Derivative

 

Amount of Gain (Loss)
Recognized in Income on
Derivative

 

 

September 30,

 

September 30,

 

 

September 30,

 

September 30,

 

 

 

September 30,

 

September 30,

 

 

2010

 

2011

 

 

2010

 

2011

 

 

 

2010

 

2011

 

Interest rate contracts

 

$

(454

)

$

(41

)

Interest expense, including the change in the fair value of non-hedged derivative instruments

 

$

(531

)

$

(371

)

Interest rate contracts

 

Interest expense, including the change in the fair value of non-hedged derivative instruments

 

$

1,391

 

$

279

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives

 

$

 

$

 

Cost of revenue

 

$

 

$

 

Fuel commodity derivatives

 

Cost of revenue

 

$

 

$

(223

)

 

 

 

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

 

 

 

 

 

 

 

for the nine months ended September 30, 2010 and 2011

 

 

 

 

 

Derivatives in
Net Investment
Hedging
Relationships

 

Amount of Gain or (Loss)
Recognized in OCI on
Derivative (Effective
Portion)

 

Location of Gain or
(Loss)Reclassified
from Accumulated
OCI into Income
(Effective Portion)

 

Amount of Loss Reclassified
from Accumulated OCI into
Income (Effective Portion)

 

Derivatives
Not
Designated as
Hedging
Instruments

 

Location of
Gain or
(Loss)
Recognized
in Income on
Derivative

 

Amount of Gain (Loss)
Recognized in Income on
Derivative

 

 

September 30,

 

September 30,

 

 

September 30,

 

September 30,

 

 

 

September 30,

 

September 30,

 

 

2010

 

2011

 

 

2010

 

2011

 

 

 

2010

 

2011

 

Interest rate contracts

 

$

(2,103

)

$

(286

)

Interest expense, including the change in the fair value of non-hedged derivative instruments

 

$

(2,282

)

$

(1,166

)

Interest rate contracts

 

Interest expense, including the change in the fair value of non-hedged derivative instruments

 

$

4,282

 

$

1,847

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives

 

$

 

$

 

Cost of revenue

 

$

 

$

 

Fuel commodity derivatives

 

Cost of revenue

 

$

 

$

(30

)

 

14



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

4.  Goodwill and Intangible Assets

 

Goodwill and intangible assets consist of the following:

 

 

 

As of December 31, 2010

 

 

 

Cost

 

Accumulated
Amortization

 

Net Book Value

 

 

 

 

 

 

 

 

 

Goodwill

 

$

58,608

 

 

 

$

58,608

 

 

 

$

58,608

 

 

 

$

58,608

 

Intangible assets:

 

 

 

 

 

 

 

Trade Name

 

$

14,050

 

$

 

$

14,050

 

Non-compete agreements

 

4,041

 

3,995

 

46

 

Contract rights

 

237,888

 

60,966

 

176,922

 

Distribution rights

 

1,623

 

621

 

1,002

 

Deferred financing costs

 

6,798

 

3,674

 

3,124

 

 

 

$

264,400

 

$

69,256

 

$

195,144

 

 

 

 

As of September 30, 2011

 

 

 

Cost

 

Accumulated
Amortization

 

Net Book Value

 

 

 

 

 

 

 

 

 

Goodwill

 

$

58,281

 

 

 

$

58,281

 

 

 

$

58,281

 

 

 

$

58,281

 

Intangible assets:

 

 

 

 

 

 

 

Trade Name

 

$

14,050

 

$

 

$

14,050

 

Non-compete agreements

 

3,187

 

3,163

 

24

 

Contract rights

 

237,798

 

69,841

 

167,957

 

Distribution rights

 

1,623

 

743

 

880

 

Deferred financing costs

 

6,798

 

4,331

 

2,467

 

 

 

$

263,456

 

$

78,078

 

$

185,378

 

 

15



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

4.  Goodwill and Intangible Assets (continued)

 

Estimated future amortization expense of intangible assets consists of the following:

 

2011 (three months)

 

$

3,709

(1)

2012

 

12,281

 

2013

 

11,960

 

2014

 

11,855

 

2015

 

11,740

 

Thereafter

 

118,830

 

 

 

$

170,375

 

 


(1)               Reflects the accelerated amortization of deferred financing costs related to the redemption of a portion of our senior notes.

 

Amortization expense of intangible assets for the nine months ended September 30, 2010 and 2011 was $9,930 and $9,676, respectively.

 

Intangible assets primarily consist of various non-compete agreements, and contract rights recorded in connection with acquisitions. The deferred financing costs were incurred in connection with our senior secured credit facility and our senior notes and are amortized from five to ten years. The non-compete agreements are amortized using the straight-line method over the life of the agreements, which range from five to fifteen years. Contract rights are amortized using the straight-line method over fifteen to twenty years. The life assigned to acquired contracts is based on several factors, including:  (i) the historical renewal rate of the contract portfolio for the most recent years prior to the acquisition, (ii) the number of years the average contract has been in the contract portfolio, (iii) the overall level of customer satisfaction within the contract portfolio, and (iv) our ability to maintain comparable renewal rates in the future. The contract rights acquired are aggregated for purposes of calculating their fair value upon acquisition due to the fact that there are thousands of individual contracts in each market. No single contract accounts for more than 2% of the revenue of any acquired portfolio and the contracts are homogeneous. The fair values of acquired portfolios are established based upon discounted cash flows generated by the acquired contracts.  The fair values of the contracts are allocated to asset groups, comprised of the Company’s geographic markets, based on an estimate of relative fair value.

 

5.  Commitments and Contingencies

 

The Company is involved in various litigation proceedings arising in the normal course of business.  In the opinion of management, the Company’s ultimate liability, if any, under pending litigation would not materially affect its financial condition or the results of its operations or cash flows.

 

16



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

6.  Earnings Per Share

 

A reconciliation of the weighted average number of common shares outstanding is as follows:

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2011

 

2010

 

2011

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations, net

 

$

826

 

$

604

 

$

3,527

 

$

3,174

 

Loss from discontinued operations, net

 

 

 

(250

)

 

Net income

 

$

826

 

$

604

 

$

3,277

 

$

3,174

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding - basic

 

13,807

 

14,286

 

13,759

 

14,207

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and restricted stock units

 

595

 

714

 

538

 

746

 

Weighted average number of common shares outstanding - diluted

 

14,402

 

15,000

 

14,297

 

14,953

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic - continuing operations

 

$

0.06

 

$

0.04

 

$

0.26

 

$

0.22

 

Earnings per share - diluted - continuing operations

 

$

0.06

 

$

0.04

 

$

0.25

 

$

0.21

 

Loss per share - basic - discontinued operations

 

$

 

$

 

$

(0.02

)

$

 

Loss per share - diluted - discontinued operations

 

$

 

$

 

$

(0.02

)

$

 

Net income per share - basic

 

$

0.06

 

$

0.04

 

$

0.24

 

$

0.22

 

Net income per share - diluted

 

$

0.06

 

$

0.04

 

$

0.23

 

$

0.21

 

 

There were 963 and 306 shares under option plans that were excluded from the computation of diluted earnings per share for the three months ended September 30, 2010 and 2011, respectively, and 952 and 294 shares under option plans that were excluded from the computation of diluted earnings per share for the nine months ended September 30, 2010 and 2011, respectively due to their anti-dilutive effects.

 

7.  Discontinued Operations

 

On February 5, 2010, the Company sold its MicroFridge® (Intirion Corporation) business to Danby Products. The transaction has been valued at approximately $11,500.  Danby Products paid Mac-Gray $8,500 in cash and assumed existing liabilities and financial obligations of MicroFridge totaling approximately $3,000.  Since the Company will not have any significant continuing involvement in the operations of this business, the Company has accounted for this business as a discontinued operation.  Prior period financial information has been restated to reflect Intirion Corporation as a discontinued operation.  The Company recorded a loss, net of taxes, as a result of this transaction, in the amount of $294.  Concurrent with this transaction, the Company paid $8,000 on its Term Loan.

 

17



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

7.  Discontinued Operations (continued)

 

Included in the table below are the key financial items related to the discontinued operation:

 

 

 

Three months

 

Nine months

 

 

 

ended

 

ended

 

 

 

September 30, 2010

 

September 30, 2010

 

 

 

 

 

 

 

Revenue

 

$

 

$

2,200

 

Interest expense, net (1)

 

$

 

$

20

 

 

 

 

 

 

 

Income before provision for income taxes

 

$

 

$

83

 

Income taxes on income from discontinued operations

 

 

39

 

Loss from disposal of discontinued operations, net of tax of $384

 

 

294

 

Loss from discontinued operations, including loss on disposal of discontinued operations, net

 

$

 

$

(250

)

 


(1)  Includes interest expense allocated to the discontinued operation as a result of a requirement to pay $8,000 on the Company’s Term Loan.  The average interest rate used to calculate this allocation was 2.5% for the nine months ended September 30, 2010.

 

8.  Stock Compensation

 

For the three and nine months ended September 30, 2011, the Company incurred stock compensation expense of $848 and $2,711, respectively. The allocation of stock compensation expense is consistent with the allocation of the participants’ salaries and other compensation expenses.

 

At September 30, 2011, options for 589 shares and 310 restricted shares have been granted but have not yet vested.

 

Compensation expense related to unvested options and restricted shares will be recognized in the following years:

 

2011 (three months)

 

$

916

 

2012

 

2,278

 

2013

 

1,183

 

2014

 

94

 

 

 

$

4,471

 

 

18



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

9.  Income Taxes

 

The following table presents the provision for income taxes and the effective income tax rates for the three and nine months ended September 30, 2010 and 2011:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2011

 

2010

 

2011

 

 

 

 

 

 

 

 

 

 

 

Provision for incomes taxes

 

$

577

 

$

515

 

$

2,537

 

$

2,204

 

Effective tax rate

 

41

%

46

%

42

%

41

%

 

The effective income tax rate on continuing operations is based upon the estimated income for the year and adjustments, if any, resulting from tax audits or other tax contingencies.

 

The changes in the effective tax rates for the three and nine months ended September 30, 2010 and 2011 are the result of the relative impact of permanent differences due to changes in estimated pretax annual profits, principally a result of charges that will occur in the fourth quarter related to the redemption of the senior notes.

 

10.  New Accounting Pronouncements

 

In October 2009, the Financial Accounting Standards Board (FASB) issued amended guidance for identifying separate deliverables in a revenue-generating transaction where multiple deliverables exist, and provides guidance for allocating and recognizing revenues based on those separate deliverables. This update also requires additional disclosure related to the significant assumptions used to determine the revenue recognition of the separate deliverables. This guidance is required to be applied prospectively to new or significantly modified revenue arrangements. The Company adopted this guidance effective January 1, 2011. The adoption of this accounting standards update did not have an impact on the Company’s consolidated income statement, balance sheet or cash flow statement.

 

In December 2010, the Financial Accounting Standards Board issued an update to accounting guidance for business combinations related to the disclosure of supplementary pro forma information. Accounting guidance for business combinations requires a public entity to disclose pro forma revenue and earnings for the combined entity as though the combination occurred at the beginning of the reporting period. This update clarifies that if a public entity presents comparative financial statements, the pro forma information for all business combinations occurring during the current year should be reported as though the combination occurred at the beginning of the prior annual reporting period. This update also expands the disclosure requirement to include the nature and amount of pro forma adjustments made to arrive at the disclosed pro forma revenue and earnings. This update is effective for business combinations for which the acquisition date is on or after annual reporting periods beginning after December 15, 2010, which is fiscal 2012 for the Company. The effect of adoption would depend on the Company’s acquisitions, if any, occurring after such date.

 

In January 2010 the FASB issued an accounting standards update modifying the disclosure requirements related to fair value measurements. Under these requirements, purchases and settlements for Level 3 fair value measurements are presented on a gross basis, rather than net. The Company adopted this guidance effective January 1, 2011.

 

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

10.  New Accounting Pronouncements (continued)

 

In May 2011, the FASB issued accounting guidance which provides common requirements for measuring fair value and disclosing information about fair value measurements in accordance with U.S. GAAP and International Financial Reporting Standards (“IFRS”). This guidance is effective for fiscal years beginning on or after December 15, 2011. The Company is currently evaluating the impact of adopting the guidance.

 

In June 2011, the FASB issued accounting guidance which improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. This guidance is effective for fiscal years beginning on or after December 15, 2011 and early adoption is permitted. The Company is currently evaluating the impact of adopting the guidance.

 

In September 2011, the FASB issued updated guidance on the periodic testing of goodwill for impairment. This guidance allows companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. This guidance is applicable for fiscal years beginning after December 15, 2011, with early adoption permitted.  The Company is currently evaluating the impact of adopting the guidance.

 

11.  Payment of dividends

 

The Company’s Board of Directors declared dividends of $0.055 per share payable on April 1, 2011, July 1, and October 1, 2011.  All dividends were paid and have been reflected in the current financial statements.

 

12.  Subsequent Events

 

On September 22, 2011 the Company issued a notice to redeem $50,000 of its senior notes effective October 21, 2011. On the effective date, the Company redeemed $50,000 of its senior notes by utilizing $51,271 of availability under its revolving credit facility.

 

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Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties.  Additional statements identified by words such as “will,” “likely,” “may,” “believe,” “expect,” “anticipate,” “intend,” “seek,” “designed,” “develop,” “would,” “future,” “can,” “could,” “outlook” and other expressions that are predictions of or indicate future events and trends and which do not relate to historical matters, also identify forward-looking statements.  These forward-looking statements reflect our current views about future events and financial performance.  Investors should not rely on forward-looking statements because they are subject to a variety of factors that could cause actual results to differ materially from our expectations.  Factors that could cause or contribute to such differences include, but are not limited to, the following:

 

·

 

debt service requirements under our existing and future indebtedness;

 

 

 

·

 

availability of cash flow to finance capital expenditures;

 

 

 

·

 

our ability to renew laundry leases with our customers;

 

 

 

·

 

competition in the laundry facilities management industry;

 

 

 

·

 

our ability to maintain relationships with our suppliers;

 

 

 

·

 

our ability to maintain adequate internal controls over financial reporting;

 

 

 

·

 

our ability to consummate acquisitions and successfully integrate the businesses we acquire;

 

 

 

·

 

increases in multi-unit housing sector apartment vacancy rates and condominium conversions;

 

 

 

·

 

our susceptibility to product liability claims;

 

 

 

·

 

our ability to protect our intellectual property and proprietary rights and create new technology;

 

 

 

·

 

our ability to retain our key personnel and attract and retain other highly skilled employees;

 

 

 

·

 

decreases in the value of our intangible assets;

 

 

 

·

 

our ability to comply with current and future environmental regulations;

 

 

 

·

 

actions of our controlling stockholders;

 

 

 

·

 

provisions of our charter and bylaws that could discourage takeovers; and

 

 

 

·

 

those factors discussed under Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010 and our other filings with the Securities and Exchange Commission (“SEC”).

 

Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations or financial condition.  In view of these uncertainties, investors are cautioned not to place undue reliance on these forward-looking statements. We assume no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

In this Quarterly Report on Form 10-Q, unless the context suggest otherwise, references to the “Company,” “Mac-Gray,” “we,” “us,” “our” and similar terms refer to Mac-Gray Corporation and its subsidiaries.  We have

 

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registered, applied to register or are using the following trademarks: Mac-Gray®, Web®, Hof, Automatic Laundry Company, LaundryView®, PrecisionWashÔ, Intelligent Laundry®, LaundryLinxÔ, TechLinxÔ, VentSnakeÔ, LaundryAuditÔ, e-issuesÔ  Life Just Got Easier® , The Laundry Room Experts®, Change Point®, The Campus Clothes Line®, and Digital Laundry is here®. The following are trademarks of parties other than us: Maytag®, Whirlpool®, Amana®, Magic Chef®, KitchenAid®, and Estate®.

 

Overview

 

Mac-Gray Corporation was founded in 1927 and re-incorporated in Delaware in 1997. Since its founding, Mac-Gray has grown to become the second largest laundry facilities management business in the United States.  Through our portfolio of card and coin-operated laundry equipment located in laundry facilities across the country, we provide laundry convenience to residents of multi-unit housing, such as apartment buildings, condominiums, colleges and universities, public housing complexes, and hotels and motels in 43 states and the District of Columbia.  Based on our ongoing survey of colleges and universities, we believe we are the largest provider of such services to the college and university market in the United States.

 

Our business model is built on a stable demand for laundry services, combined with long-term leases, strong customer relationships, a broad customer base, and predictable capital needs.  For the three and nine months ended September 30, 2011, our total revenue was $78,492 and $239,374, respectively. Approximately 95% of our total revenue for the three and nine month period was generated by our facilities management business.  We generate facilities management revenue primarily by entering into long-term leases with property owners or property management companies for the exclusive right to install and maintain laundry equipment in common area laundry rooms within their properties in exchange for a negotiated portion of the revenue we collect.  As of September 30, 2011, approximately 87% of our installed equipment base was located in laundry facilities subject to long-term leases, which have a weighted average remaining term of approximately four years.  Our capital costs are typically incurred in connection with new or renewed leases, and include investments in laundry equipment and card and coin-operated systems, incentive payments to property owners or property management companies, and expenses to refurbish laundry facilities.  Our capital costs consist primarily of a large number of relatively small amounts, which are associated with our entry into or renewal of leases. Our capital needs other than for laundry leases are not significant.  Accordingly, our capital needs are predictable and largely within our control.  For the three and nine months ended September 30, 2011, we incurred $6,500 and $22,026 of capital expenditures, respectively. In addition, we made incentive payments of approximately $734 and $2,588 in the three and nine months ended September 30, 2011 to property owners and property management companies in connection with obtaining our lease arrangements.

 

Through our commercial equipment sales and services business, we generate revenue by selling commercial laundry equipment.  For the three and nine months ended September 30, 2011, our commercial laundry equipment sales business generated approximately 5% of our total revenue, and 8% and 5% of our gross margin, respectively. We anticipate that tight credit markets for our customers will continue to challenge our ability to maintain and grow our revenue from laundry equipment sales.

 

Our current priorities include: (i) continuing to reduce funded debt, thereby improving debt leverage ratios and reducing interest expense, (ii) maintaining capital expenditures at the levels needed to sustain and grow the business, (iii) increasing facilities management operating efficiencies in all markets, particularly the ones that have been influenced by acquisition activity in the past five years, (iv) improving the profitability of individual laundry facilities management accounts that come up for contract renewal, and (v) continuing to look for acquisitions that complement our current footprint.  One of the key challenges we face is maintaining and expanding our customer base in a competitive industry. Approximately 10% to 15% of our laundry room leases are up for renewal each year.  Within any given geographic area, Mac-Gray may compete with local independent operators, regional operators and multi-region operators as well as property owners and property management companies who self-operate their laundry facilities. We devote substantial resources to our sales efforts and are focused on continued innovation in order to distinguish us from our competitors.

 

On October 21, 2011, we redeemed $50,000 of our senior notes using approximately $51 million of availability under the revolver portion of its senior credit agreement.  The redemption price for the notes was 102.542%. Under the terms of its credit agreement, Mac-Gray will pay an interest rate of LIBOR plus a spread of between 2% and 2.5% on the funds borrowed to redeem the notes. If there is not a significant change in LIBOR, we expect the cash payback on this strategy to be approximately six to eight months.

 

The Company’s Board of Directors declared a dividend of $0.55 per share payable on October 1, 2011 to stockholders of record at the close of business on September 15, 2011. All dividends were paid and have been

 

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reflected in the current financial statements.

 

On February 5, 2010, the Company sold its MicroFridge® (Intirion Corporation) business to Danby Products. The following discussion excludes the financial results from our discontinued operations unless otherwise noted. Prior period results have been reclassified to conform to this presentation.

 

Results of Operations (Dollars in thousands)

 

Three and nine months ended September 30, 2011 compared to three and nine months ended September 30, 2010.

 

The information presented below for the three and nine months ended September 30, 2011 and 2010 is derived from our unaudited condensed consolidated financial statements and related notes included elsewhere in this report:

 

 

 

For the three months ended September 30,

 

 

 

 

 

 

 

Increase

 

%

 

 

 

2010

 

2011

 

(Decrease)

 

Change

 

Laundry facilities management revenue

 

$

73,882

 

$

74,287

 

$

405

 

1

%

Commercial laundry equipment sales revenue

 

4,359

 

4,205

 

(154

)

-4

%

Total revenue from continuing operations

 

$

78,241

 

$

78,492

 

$

251

 

0

%

 

 

 

For the nine months ended September 30,

 

 

 

 

 

 

 

Increase

 

%

 

 

 

2010

 

2011

 

(Decrease)

 

Change

 

Laundry facilities management revenue

 

$

226,417

 

$

228,435

 

$

2,018

 

1

%

Commercial laundry equipment sales revenue

 

11,868

 

10,939

 

(929

)

-8

%

Total revenue from continuing operations

 

$

238,285

 

$

239,374

 

$

1,089

 

0

%

 

Revenue

 

Total revenue increased by $251, or less than 1%, to $78,492 for the three months ended September 30, 2011 compared to $78,241 for the three months ended September 30, 2010. Total revenue increased by $1,089, or less than 1%, to $239,374 for the nine months ended September 30, 2011 compared to $238,285 for the nine months ended September 30, 2010.

 

Laundry facilities management revenue.  Laundry facilities management revenue increased by $405, or less than 1%, to $74,287 for the three months ended September 30, 2011 compared to $73,882 for the three months ended September 30, 2010. Laundry facilities management revenue increased by $2,018, or 1%, to $228,435 for the nine months ended September 30, 2011 compared to $226,417 for the nine months ended September 30, 2010. The Company has undertaken a comprehensive review of vend prices in certain markets and has instituted vend increases where appropriate.  The increase in revenue is attributable in part to this program. The increase in revenue is also the result of the net increased usage of the Company’s equipment in the markets in which the Company conducts business which the Company believes is due to apartment occupancy rates improving in some of our markets.  The occupancy rates in the type of multi-family apartments in which we operate have begun to improve but at a slower rate than the overall national average. We expect occupancy rates below historical norms to continue to have a negative impact on our facilities management business in several of our markets in the near term but to a lesser extent than it has in the recent past.  We continue to track the change in revenue month over month and quarter over quarter in our markets to better understand the revenue trend for our multi-family housing customers. This analysis is used to enable us to respond to changing trends in different geographic markets and to enable us to better allocate capital spending.

 

Commercial laundry equipment sales.  Revenue in the commercial laundry equipment sales business decreased by $154, or 4%, to $4,205 for the three months ended September 30, 2011 compared to $4,359 for the three

 

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months ended September 30, 2010. Revenue in the commercial laundry equipment sales business decreased by $929, or 8%, to $10,939 for the nine months ended September 30, 2011 compared to $11,868 for the nine months ended September 30, 2010.  Sales in the commercial laundry equipment sales business are sensitive to the strength of the local economy, the availability and cost of financing to small businesses, consumer confidence, and local permitting and therefore, tend to fluctuate significantly from period to period.  The continued weak economy and high unemployment rate continue to discourage our potential customers from committing to capital investments. These factors challenge our ability to maintain or grow our revenue from laundry equipment sales in the near term.

 

Cost of revenue

 

Cost of laundry facilities management revenue.  Cost of laundry facilities management revenue includes rent paid to customers as well as those costs associated with installing and servicing equipment and costs of collecting, counting, and depositing facilities management revenue. Cost of laundry facilities management revenue increased by $1,165, or 2%, to $52,004 for the three months ended September 30, 2011 as compared to $50,839 for the three months ended September 30, 2010. Cost of laundry facilities management revenue increased by $2,727, or 2%, to $157,560 for the nine months ended September 30, 2011 as compared to $154,833 for the nine months ended September 30, 2010.  As a percentage of laundry facilities management revenue, cost of laundry facilities management revenue was 70% and 69% for the three months ended September 30, 2011 and 2010, respectively, and 69% and 68% for the nine months ended September 30, 2011 and 2010, respectively. Laundry facilities management rent increased 2.2% and 1.3% for the three and nine months ended September 30, 2011 compared to the corresponding periods in 2010, directly attributable to the increase in facilities management revenue. Laundry facilities management rent as a percentage of laundry facilities management revenue was 49.0 % and 48.2% for the three months ended September 30, 2011 and 2010, respectively. Laundry facilities management rent as a percentage of laundry facilities management revenue was 48.8% and 48.6% for the nine months ended September 30, 2011 and 2010, respectively. Laundry facilities management rent can be affected by new and renewed laundry leases and by other factors such as the amount of incentive payments and laundry room betterments invested in new or renewed laundry leases. As we vary the amount invested in a facility, the laundry facilities management rent, as a function of laundry facilities management revenue, can vary. Other costs of laundry facilities management revenue increased by $393, or 2.6%, to $15,591 for the three months ended September 30, 2011 compared to $15,198 for the three months ended September 30, 2010. Other costs of laundry facilities management revenue increased by $1,296, or 2.9%, to $46,045 for the nine months ended September 30, 2011 compared to $44,749 for the nine months ended September 30, 2010. The increase in operating expenses for the three months ended September 30, 2011 compared to the same period in 2010 is attributable to cost increases associated with our fleet of vehicles, primarily fuel.  The increase was offset, in part, by a reduction in the use of outside services and a reduction in occupancy costs.  The increase in operating expenses for the nine months ended September 30, 2011 compared to the same period in 2010 is also attributable to cost increases associated with our fleet of vehicles and increased personnel costs.

 

Depreciation and amortization related to operations.  Depreciation and amortization related to operations decreased by $1,119, or 10%, to $10,568 for the three months ended September 30, 2011 as compared to $11,687 for the three months ended September 30, 2010. Depreciation and amortization related to operations decreased by $1,750, or 5%, to $32,512 for the nine months ended September 30, 2011 as compared to $34,262 for the nine months ended September 30, 2010.The decrease in depreciation and amortization for the three and nine months ended September 30, 2011 as compared to the same period in 2010 is attributable to the Company’s decision, in the past two years, to closely manage capital investment in light of the recent uncertain economy. We have begun to increase our capital spending and expect depreciation expense to begin to increase. The fact that much of the equipment we acquired as part of acquisitions we made in recent years was assigned a shorter average life than that assigned to new capital investment and is now fully depreciated has also contributed to lower depreciation expense.

 

Cost of laundry equipment sales.  Cost of commercial laundry equipment sales consists primarily of the cost of laundry equipment, and parts and supplies sold, as well as salaries, warehousing and distribution expenses.  Cost of commercial laundry equipment sales decreased by $213, or 6%, to $3,144 for the three months ended September 30, 2011 as compared to $3,357 for the three months ended September 30, 2010. Cost of commercial laundry equipment sales decreased by $746, or 8%, to $8,722 for the nine months ended September 30, 2011 as compared to $9,468 for the nine months ended September 30, 2010. As a percentage of sales, cost of product sold was 75% and 77% for the three months ended September 30, 2011 and 2010, respectively, and 80% for the nine months ended September 30, 2011 and 2010, respectively. The decrease in cost of sales for the three and nine months ended September 30, 2011 compared to the same periods ending

 

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September 30, 2011 is a direct result of the decrease in revenue.  Operating expenses were essentially unchanged in total. The gross margin in the commercial laundry equipment sales business unit was 25% and 23% for the three months ended September 30, 2011 and 2010, respectively, and 20% for the nine months ended September 30, 2011 and 2010, respectively. The fluctuation in gross margins in the three months ended September 30, 2011 compared to the same period in 2010 is due primarily to product mix.

 

Operating expenses

 

General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs.  General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs decreased by $153, or 2%, to $8,207 for the three months ended September 30, 2011 as compared to $8,360 for the three months ended September 30, 2010. General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs increased by $652, or 3%, to $25,866 for the nine months ended September 30, 2011 as compared to $25,214 for the nine months ended September 30, 2010. As a percentage of total revenue, these expenses were 10% and 11% for the three months ended September 30, 2011 and 2010, respectively, and 11% for the nine months ended September 30, 2011 and 2010. The decrease in expenses for the three months and increase for the nine months ended September 30, 2011 as compared to the three and nine months ended September 30, 2010 is the net impact of changes in expenses incurred in several categories including personnel related expenses, professional fees and outside services.

 

Gain on sale of assets

 

The gains of $170 and $208 in the nine months ended September 30, 2011 and 2010, respectively, are from the sale of vehicles and other fixed assets in the normal course of business.

 

Income from continuing operations

 

Income from continuing operations increased by $489, or 12%, to $4,582 for the three months ended September 30, 2011 compared to $4,093 for the three months ended September 30, 2010 and increased by $168, or 1%, to $14,884 for the nine months ended September 30, 2011 compared to $14,716 for the nine months ended September 30, 2010 due primarily to the cumulative effect of the reasons discussed above.

 

Interest expense, including the change in the fair value of non-hedged derivative instruments

 

Interest expense, including the change in the fair value of non-hedged derivative instruments, increased by $773, or 29%, to $3,463 for the three months ended September 30, 2011, as compared to $2,690 for the three months ended September 30, 2010. This increase was the net of a $1,044 decrease in the unrealized gain on interest rate contracts that do not qualify for hedge accounting and a $271 decrease in interest on debt.  Interest expense, including the change in the fair value of non-hedged derivative instruments, increased by $854, or 10%, to $9,506 for the nine months ended September 30, 2011, as compared to $8,652 for the nine months ended September 30, 2010. This increase was the net of a $2,325 decrease in the unrealized gain on interest rate contracts that do not qualify for hedge accounting and a $1,471 decrease in interest on debt.  Interest expense, excluding the change in fair value of non-hedged derivative instruments, was $3,508 and $3,779 for the three months ended September 30, 2011 and 2010, respectively, a decrease of $271 or 7%.  Interest expense, excluding the change in fair value of non-hedged derivative instruments, was $9,993 and $11,464 for the nine months ended September 30, 2011 and 2010, respectively, a decrease of $1,471 or 13%. The decreases in interest on debt are primarily attributable the expiration of two derivative instruments at December 31, 2010 which were at interest rates above current rates. The decrease in interest expense was also the result of favorable interest rates and the continued reduction in debt by the Company.

 

One of our interest rate Swap Agreements qualifies as a cash flow hedge while the others do not.  The changes in the fair value of the interest rate Swap Agreements that do not qualify for hedge accounting treatment are recognized in the income statement in the period in which the changes occur. The effective portion of the interest rate Swap Agreement that qualifies for hedge accounting is included in Other Comprehensive Loss in the period in which change occurs, while the ineffective portion, if any, is recognized in income in the period in which the change occurs.

 

During the first quarter of 2010 the Company no longer qualified for hedge accounting treatment for one of its interest rate swap agreements.  Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost must be reclassified as an earnings charge through the maturity date of

 

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the derivative.  This charge amounted to $100 and $199 for the three months ended September 30, 2011 and 2010, respectively, and $371 and $1,083 for the nine months ended September 30, 2011 and 2010, respectively. The remaining balance of $230 associated with this interest rate swap, and included in Accumulated Other Comprehensive Loss, will be charged against income through the maturity date of the interest rate swap agreement on April 1, 2013.

 

Provision for income taxes

 

The provision for income taxes decreased by $62 to $515 for the three months ended September 30, 2011 compared to the provision for income taxes of $577 for the three months ended September 30, 2010. The provision for income taxes decreased by $333 to $2,204 for the nine months ended September 30, 2011 compared to the provision for income taxes of $2,537 for the nine months ended September 30, 2010. The decrease is the result of the decrease in pre-tax income to $1,119 and $5,378 for the three and nine months ended September 30, 2011, respectively, compared to the pre-tax income of $1,403 and $6,064 for the three and nine months ended September 30, 2010, respectively. The effective tax rate decreased to 41.0% from 41.8% for the nine months ended September 30, 2011, compared to the same period in 2010. The changes in the effective rate for the three and nine months ended September 30, 2011 are the result of the relative impact of permanent differences due to changes in estimated pretax annual profits, principally a result of charges that will occur in the fourth quarter related to the redemption of the senior notes.

 

Income from continuing operations, net

 

As a result of the foregoing, income from continuing operations, net decreased by $222 to $604 for the three months ended September 30, 2011 compared to $826 for the same period ended September 30, 2010. Income from continuing operations, net decreased by $353 to $3,174 for the nine months ended September 30, 2011 compared to $3,527 for the same period ended September 30, 2010.

 

Income from discontinued operations, net

 

Income from discontinued operations, net, excluding loss on disposal was $44 for the nine months ended September 30, 2010.  The Company sold its MicroFridge®( Intirion Corporation) business on February 5, 2010.

 

Seasonality

 

We experience moderate seasonality as a result of our operations in the college and university market. Revenues derived from the college and university market represented approximately 13% of our total laundry facilities management revenue. Academic facilities management and rental revenues are derived substantially during the school year in the first, second and fourth calendar quarters. Conversely, our operating and capital expenditures have historically been higher during the third calendar quarter when we install a large amount of equipment while colleges and universities are generally on summer break.

 

Liquidity and Capital Resources (Dollars in thousands)

 

We believe that we can satisfy our working capital requirements and funding of capital needs with internally generated cash flow and, as necessary, borrowings from our revolving credit facility described below. Capital requirements for the year ending December 31, 2011, including contract incentive payments, are currently expected to be between $33,000 and $36,000.  In the nine months ended September 30, 2011, spending on capital expenditures was $ 22,026 and contract incentives was $2,588. The capital expenditures for 2011 are primarily composed of laundry equipment installed in connection with new customer leases and the renewal of existing leases.

 

We historically have not needed sources of financing other than our internally generated cash flow and revolving credit facilities to fund our working capital, capital expenditures and smaller acquisitions. As a result, we anticipate that our cash flow from operations and revolving credit facilities will be sufficient to meet our anticipated cash requirements for at least the next twelve months including the impact that the redemption of the senior notes will have on our revolving credit facilities.  However, we may require external sources of financing for any significant future acquisitions.  Further, our senior secured credit facilities mature in April 2013 and our senior notes mature in August 2015.  We anticipate that we will need to refinance some portion of our indebtedness or otherwise amend the terms when they reach maturity.

 

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Our current long-term liquidity needs are principally the repayment of the outstanding principal amounts of our long-term indebtedness, including borrowings under our senior credit facility and our senior notes. We are unable to project with certainty whether our long-term cash flow from operation will be sufficient to repay our long-term debt when it comes due. In particular, our senior secured credit agreement matures in April, 2013 and our senior unsecured notes mature in August, 2015. We anticipate that we will need to refinance some portion of this indebtedness when it reaches maturity.  We cannot make any assurances that such financing would be available on reasonable terms, if at all.

 

For the nine months ended September 30, 2011, our source of cash was primarily from operating activities. Our primary uses of cash for the nine months ended September 30, 2011 were the purchase of new laundry equipment, the reduction of debt, and the payments of dividends. We anticipate that we will continue to use cash flows provided by operating activities to finance working capital needs, debt service, and capital expenditures.

 

Our senior secured credit agreement (the “Secured Credit Agreement”) provides that we may borrow up to $149,500 in the aggregate, including $19,500 pursuant to a Term Loan and up to $130,000 pursuant to a Revolver.  The Term Loan requires quarterly principal payments of $750 at the end of each calendar quarter through December 31, 2012, with the remaining principal balance of $15,750 due on April 1, 2013. The Secured Credit Agreement also provides for Bank of America, N. A. to make swingline loans to us of up to $10,000 (the “Swingline Loans”) and any Swingline Loans will reduce the borrowings available under the Revolver.  Subject to certain terms and conditions, the Secured Credit Agreement gives the Company the option to establish additional term and/or revolving credit facilities thereunder, provided that the aggregate commitments under the Secured Credit Agreement cannot exceed $220,000.

 

Borrowings outstanding under the Secured Credit Agreement bear interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate (adjusted for statutory reserves) plus an applicable percentage, ranging from 2.00% to 2.50% per annum (currently 2.00%), determined by reference to our senior secured leverage ratio, and (ii) in the case of base rate loans and Swingline Loans, the higher of (a) the federal funds rate plus 0.5% or (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” in each case, plus an applicable percentage, ranging from 1.00% to 1.50% per annum (currently 1.00%), determined by reference to our senior secured leverage ratio.

 

The obligations under the Secured Credit Agreement are guaranteed by our subsidiaries and collateralized by (i) a pledge of 100% of the ownership interests in the subsidiaries, and (ii) a first-priority security interest in substantially all our tangible and intangible assets.

 

Under the Secured Credit Agreement, we are subject to customary lending covenants, including restrictions pertaining to, among other things: (i) the incurrence of additional indebtedness, (ii) limitations on liens, (iii) making distributions, dividends and other payments, (iv) the making of certain investments and loans, (v) mergers, consolidations and acquisitions, (vi) dispositions of assets, (vii) the maintenance of a maximum total leverage ratio of not greater than 4.25 to 1.00, a maximum senior secured leverage ratio of not greater than 2.50 to 1.00, and a minimum consolidated cash flow coverage ratio of not less than 1.20 to 1.00, (viii) transactions with affiliates, and (ix) changes to governing documents and subordinate debt documents, in each case subject to baskets, exceptions and thresholds.  We were in compliance with these and all other financial covenants at September 30, 2011.

 

The Secured Credit Agreement provides for customary events of default with, in some cases, corresponding grace periods, including (i) failure to pay any principal or interest when due, (ii) failure to comply with covenants, (iii) any representation or warranty made by us proving to be incorrect in any material respect, (iv) payment defaults relating to, or acceleration of, other material indebtedness, (v) certain bankruptcy, insolvency or receivership events affecting us, (vi) a change in our control, (vii) the Company or its subsidiaries becoming subject to certain material judgments, claims or liabilities, or (viii) a material defect in the lenders’ lien against the collateral securing the obligations under the Secured Credit Agreement.

 

In the event of an event of default, the Administrative Agent may, and at the request of the requisite number of lenders under the Secured Credit Agreement must, terminate the lenders’ commitments to make loans under the Secured Credit Agreement and declare all obligations under the Secured Credit Agreement immediately due and payable.  For certain events of default related to bankruptcy, insolvency and receivership, the commitments of the lenders will be automatically terminated and all of our outstanding obligations under the Secured Credit Agreement will become immediately due and payable.

 

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We pay a commitment fee equal to a percentage of the actual daily unused portion of the Revolver under the Secured Credit Agreement.  This percentage, currently 0.300% per annum, will be determined quarterly by reference to the senior secured leverage ratio and will range between 0.300% per annum and 0.500% per annum.

 

As of September 30, 2011, there was $40,773 outstanding under the Revolver, $19,500 outstanding under the Term Loan and $1,380 in outstanding letters of credit.  The available balance under the Revolver was $87,847 at September 30, 2011. The average interest rates on the borrowings outstanding under the Secured Credit Agreement at September, 2010 and 2011 were 7.03% and 5.71%, respectively, including the applicable spread paid to the banks and the effect of the interest rate swap agreements tied to the debt.

 

On August 16, 2005, we issued senior unsecured notes in the amount of $150,000. These notes bear interest at 7.625% payable semi-annually each February and August. A portion of the senior notes are tied to an interest rate swap agreement.  After taking the swap agreement into effect, the average interest rates on the senior notes at September 30, 2010 and 2011 was 5.86% and 7.63%, respectively.  The maturity date of the notes is August 15, 2015. The proceeds from the senior notes, less financing costs, were used to pay down senior bank debt.  The market value of these notes approximates book value at September 30, 2011.

 

The Company has the option to redeem all or a portion of the senior notes at the redemption prices (expressed in percentages of principal amount on the redemption date), plus accrued interest to the redemption date, if redeemed, during the 12-month period commencing on August 15 of the years set forth below:

 

 

 

Remdemption

 

Period

 

Price

 

2011

 

102.542

%

2012

 

101.271

%

2013 and thereafter

 

100.000

%

 

On October 21, 2011, the Company redeemed $50,000 of its senior notes by utilizing $51,271 of availability under its revolving credit facility.  As the revolving credit facility has a maturity date greater than one year and is presented within long term debt at September 30, 2011, the company has classified the $50,000 of the senior notes as a long term liability at September 30, 2011.

 

The terms of the senior notes include customary covenants, including, but not limited to, restrictions pertaining to: (i) incurrence of additional indebtedness and issuance of preferred stock, (ii) payment of dividends on or making of distributions in respect of capital stock or making certain other restricted payments or investments, (iii) entering into agreements that restrict distributions from restricted subsidiaries, (iv) sale or other disposition of assets, including capital stock of restricted subsidiaries, (v) transactions with affiliates, (vi) incurrence of liens, (vii) sale/leaseback transactions, and (viii) merger, consolidation or sale of substantially all of our assets, in each case subject to numerous baskets, exceptions and thresholds. We were in compliance with these and all other financial covenants at September 30, 2011.

 

The terms of the senior notes provide for customary events of default, including, but not limited to: (i) failure to pay any principal or interest when due, (ii) failure to comply with covenants and limitations, (iii) certain insolvency or receivership events affecting us or any of our subsidiaries, and (iv) unsatisfied material judgments, claims or liabilities against us. There were no events of default under the senior notes at September 30, 2011.

 

Operating Activities

 

For the nine months ended September 30, 2011 and 2010, net cash flows provided by operating activities were $36,101 and $34,865, respectively. Cash flows from operations consists primarily of facilities management revenue and equipment sales, offset by the cost of facilities management revenues, cost of product sold, and general, administration, sales and marketing expenses. The most significant changes to cash flows for the nine months ended September 30, 2011 as compared to the nine months ended September 30, 2010 are an increase in prepaid facilities management rent and other assets in 2011 compared to decrease in 2010 and an increase in accounts payable, accrued facilities management rent, accrued expenses and other liabilities in 2011 compared to a decrease in 2010. These accounts are subject to normal fluctuations period to period.  Non-cash derivative

 

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interest income declined in 2011 compared to 2010 due to the change in mark to market values of our interest derivatives that do not qualify for hedge accounting.

 

Investing Activities

 

For the nine months ended September 30, 2011 and 2010, net cash flows used in investing activities were $21,795 and $8,015, respectively.  Capital expenditures for the nine months ended September 30, 2011 and 2010 were $22,026 and $16,750, respectively, primarily for the acquisition of laundry equipment for new and renewed lease locations.  Cash flows of $8,274 in the nine months ended September 30, 2010 provided by investing activities consist of the proceeds from the sale of Intirion Corporation.

 

Financing Activities

 

For the nine months ended September 30, 2011 and 2010, net cash flows used in financing activities were $14,385 and $35,446, respectively. Cash flows used in financing activities consist of net reductions in bank borrowings and for the nine months ended September 30, 2010 include the $8,000 reduction in the Term Loan from the proceeds of the sale of Intirion Corporation and the payments of cash dividends.  Cash flows provided by financing activities consist of proceeds from the exercise of options and the issuance of stock through the employee stock purchase program.

 

The Company has entered into standard International Swaps and Derivatives Association, or ISDA, interest rate Swap Agreements to manage the interest rate associated with our senior credit facilities. For a description of our interest rate Swap Agreements see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”

 

Contractual Obligations

 

A summary of our contractual obligations and commitments related to our outstanding long-term debt and future minimum lease payments related to our vehicle fleet, warehouse rent and facilities management rent as of September 30, 2011 is as follows:

 

 

 

 

 

 

 

Interest on

 

 

 

 

 

 

 

 

 

Fiscal

 

Long-term

 

Interest on

 

variable rate

 

Facilites rent

 

Capital lease

 

Operating lease

 

 

 

Year

 

debt

 

senior notes (2)

 

debt (1)

 

commitments

 

commitments

 

commitments

 

Total

 

2011(three months)

 

$

750

(3)

$

 

$

1,423

 

$

4,169

 

$

329

 

$

880

 

$

7,551

 

2012

 

3,000

 

7,625

 

6,254

 

16,323

 

1,182

 

3,264

 

$

37,648

 

2013

 

106,523

 

7,625

 

1,521

 

13,258

 

921

 

2,651

 

$

132,499

 

2014

 

 

7,625

 

 

10,192

 

495

 

2,353

 

$

20,665

 

2015

 

100,000

 

7,625

 

 

7,379

 

32

 

2,031

 

$

117,067

 

Thereafter

 

 

 

 

17,938

 

 

527

 

$

18,465

 

Total

 

$

210,273

 

$

30,500

 

$

9,198

 

$

69,259

 

$

2,959

 

$

11,706

 

$

333,895

 

 


(1)

 

Interest is calculated using the Company’s average interest rate at September 30, 2011.

(2)

 

Reflects the redemption of the $50,000 in senior notes on October 21, 2011.

(3)

 

The redemption of the $50,000 in senior notes discussed in Note 2, Long-Term Debt, is not reflected in the 2011 payments amount as the $50,000 was borrowed from our revolving credit facility and is due at maturity on April 1, 2013.

 

Item 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT

MARKET RISK

 

We are exposed to a variety of risks, including changes in interest rates on some of our borrowings and the change in fuel prices. In the normal course of our business, we manage our exposure to these risks as described below. We do not engage in trading market-risk sensitive instruments for speculative purposes.

 

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Interest rates

 

The table below provides information about our debt obligations that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. The fair market value of long-term debt approximates book value at September 30, 2011.

 

(in thousands)

 

2011

 

2012

 

2013

 

2014

 

2015

 

Thereafter

 

Total

 

Variable rate

 

$

750

 

$

3,000

 

$

106,523

 

$

 

$

 

$

— 

 

$

110,273

 

Average interest rate

 

5.71

%

5.71

%

5.71

%

 

 

 

5.71

%

 

We have entered into standard International Swaps and Derivatives Association interest rate swap agreements to manage the interest rate associated with our debt. The interest rate Swap Agreements effectively convert a portion of our variable rate debt to a long-term fixed rate. Under these agreements, we receive a variable rate of LIBOR plus a markup and pay a fixed rate.

 

The Company also entered into an interest rate swap agreement to manage the interest rate associated with its senior unsecured notes. This interest rate swap agreement converted a portion ($100 million) of our fixed rate senior unsecured notes to a variable rate. Under this interest rate swap agreement the Company received a fixed rate of 7.625% and paid a variable rate of LIBOR plus the applicable margin charged by the banks. This interest rate swap agreement had an associated call feature that allowed the counterparty to terminate this agreement at their option. On July 22, 2011 the counterparty exercised their right to terminate this agreement effective August 21, 2011. The Company received proceeds from this termination in the amount of $2,542.  This amount is reflected in the operating section of the Cash Flow Statement.

 

In December 2010 the Company entered into a fuel commodity derivative to manage the fuel cost of its fleet of vehicles. The derivative is effective April 1, 2011 and expires December 31, 2011.  The derivative has a monthly notional amount of 80 thousand gallons from April 1, 2011 through December 31, 2011 for a total notional amount of 720 thousand gallons.  The Company has a put price of $3.015 per gallon and a strike price of $3.50 per gallon. On September 23, 2011 the Company entered into additional fuel commodity derivative. This derivative has a monthly notional amount of 85 thousand gallons and is effective from January 1, 2012 through December 31, 2012 for a total notional amount of 1.02 million gallons. The Company has a put price of $3.205 per gallon and a strike price of $3.70 per gallon. The Company recognized a non-cash unrealized loss of $255 and $133 for the three and nine months ended September 30, 2011, respectively, on these fuel commodity derivatives as a result of the change in the fair value.

 

The fair values of the interest rate derivatives are based on quoted prices for similar instruments from a commercial bank.  These derivatives are considered to be Level 2 items.  The fuel commodity derivative is based on market assumptions and a quoted price from the counter party and is considered a Level 3 item.

 

One of our interest rate Swap Agreements qualifies as a cash flow hedge while the others do not. The change in the fair value of the interest rate Swap Agreements that do not qualify for hedge accounting treatment is recognized in the income statement in the period in which the change occurs. The effective portion of the interest rate Swap Agreement that qualifies for hedge accounting is included in Other Comprehensive Income in the period in which the change occurs, while the ineffective portion, if any, is recognized in income in the period in which the change occurs.

 

During the first quarter of 2010 we no longer qualified for hedge accounting treatment for one of our interest rate swap agreements. Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time the hedge accounting was lost must be reclassified as an earnings charge through the maturity date of the derivative. This charge amounted to $100 and $371 for the three and nine months ended September 30, 2011 compared to $199 and $1,083 for the three and nine months ended September 30, 2010, respectively. The remaining balance of $230 associated with this interest rate swap and included in Accumulated Other Comprehensive Loss will be charged against income through the maturity date of the interest rate swap agreement on April 1, 2013.

 

The table below outlines the details of each remaining interest rate Swap Agreement:

 

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Notional

 

Notional

 

 

 

 

 

 

 

Original

 

Amount

 

Amount

 

 

 

 

 

Date of

 

Notional

 

Fixed/

 

June 30,

 

Expiration

 

Fixed

 

Origin

 

Amount

 

Amortizing

 

2011

 

Date

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

May 8, 2008

 

$

45,000

 

Amortizing

 

$

30,000

 

Apr 1, 2013

 

3.78

%

May 8, 2008

 

$

40,000

 

Amortizing

 

$

27,000

 

Apr 1, 2013

 

3.78

%

 

In accordance with the interest rate Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate. With regard to our floating to fixed rate interest rate swap agreements, if interest expense, as calculated, is greater based on the 90-day LIBOR, the financial institution pays the difference to us.  If interest expense, as calculated, is greater based on the fixed rate we pay the difference to the financial institution. With regard to our fixed to floating rate interest rate swap agreement, if interest expense, as calculated, is greater based on the 90-day LIBOR, we pay the difference to the financial institution.  If interest expense, as calculated, is greater based on the fixed rate, the financial institution pays the difference to us.

 

Depending on fluctuations in the LIBOR, our interest rate exposure and the related impact on interest expense and net cash flow may increase or decrease. The counter party to the interest rate Swap Agreements exposes us to credit loss in the event of non-performance; however, nonperformance is not anticipated.  The fair value of an interest rate Swap Agreement is the estimated amount that we would receive or pay to terminate the agreement at the reporting date, taking into account current interest rates and the credit worthiness of the counter party. At September 30, 2011, the fair value of the interest rate Swap Agreements was a liability of $2,592.  This amount has been included in other liabilities on the condensed consolidated balance sheets.

 

Item 4.

 

CONTROLS AND PROCEDURES

 

Evaluation of disclosure controls and procedures.  As of the end of the period covered by this report, an evaluation was carried out by our management, with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)).  Based upon that evaluation, our chief executive officer and chief financial officer concluded that these disclosure controls and procedures were effective as of September 30, 2011 in providing reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

Changes in internal controls.  In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during the quarter ended September 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II — OTHER INFORMATION

 

Item 1A. Risk Factors

 

There have been no material changes in our risk factors from those disclosed in Part 1, Item 1A (“Risk Factors”) of our Annual Report on Form 10-K for the fiscal year ended December 31, 2010, except to the extent previously updated or to the extent additional factual information disclosed elsewhere in this Quarterly Report on Form 10-Q relates to such risk factors.  The risks described in our annual report on Form 10-K are not the only risks facing our Company.  Additional risks and uncertainties not currently known to us or that we

 

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currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

 

Item 6.    Exhibits

 

31.1

 

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)

31.2

 

Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)

32.1

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2)

101

 

The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 formatted in eXtensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Income Statements, (iii) the Condensed Consolidated Statements of Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows and (v) related notes, tagged as blocks of text. (2)

 


(1) Filed herewith.

(2) Furnished herewith.

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunder duly authorized.

 

 

 

MAC-GRAY CORPORATION

November 4, 2011

/s/  Michael J. Shea

 

Michael J. Shea

 

Executive Vice President, Chief

 

Financial Officer and Treasurer

 

(On behalf of registrant and as principal

 

financial officer)

 

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