Item 1. Business
Overview
Unless the context requires otherwise, all references in this report to "we," "our," "Mac-Gray," the "Company," or "us" means Mac-Gray Corporation and its subsidiaries and predecessors.
Mac-Gray Corporation was founded in 1927 and reincorporated in Delaware in 1997. Since its founding, Mac-Gray has grown to become the second largest laundry facilities management contractor 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 university residence halls, public housing complexes, and hotels and motels. Based on our ongoing survey of colleges and universities, we believe that we are the largest provider of such services to the college and university market in the United States.
We derive our revenue principally as a laundry facilities management contractor for the multi-unit housing industry. We manage laundry rooms under long-term leases with property owners, property management companies and colleges and universities. We refer to these leases as "laundry leases", or "management contracts," and this business as "laundry facilities management business." In 2010, 95% of our consolidated revenue from continuing operations was derived from our laundry facilities management business. As of December 31, 2010, our laundry facilities management business had revenue-generating laundry equipment operating in 43 states and the District of Columbia.
Our laundry equipment sales business sells and services commercial laundry equipment manufactured by Whirlpool Corporation, Dexter Laundry Company, American Dryer Corporation, and Primus Laundry Company. This business sells commercial laundry equipment primarily to retail laundromats, hotels and similar institutional users that operate their own on-premise laundry facilities. We refer to this business as our "commercial laundry equipment sales business."
On February 5, 2010, we sold our MicroFridge® (Intirion Corporation) business to Danby Products. The following discussion excludes the financial results from our discontinued operations unless otherwise noted. The results from all prior periods have been reclassified to conform to this presentation.
Laundry Facilities Management Business
For the years ended December 31, 2009 and 2010, our laundry facilities management business accounted for approximately 95% of our total revenue from continuing operations, and 94% and 95% of our gross margin from continuing operations, respectively. Through our laundry facilities management business, we act as a laundry facilities management contractor with property owners or managers. We lease space within a property, in some instances improve the leased space with flooring, ceilings and other improvements ("betterments") and then install and service the laundry equipment and collect the payments. The property owner or manager is usually responsible for maintaining, cleaning, and securing the premises and payment of utilities. Under our long-term leases, we typically receive the exclusive right to provide and service laundry equipment within a multi-unit housing property in exchange for a negotiated percentage of the total revenue collected. We refer to this percentage as "facilities management rent." In each of the past five years, we have retained approximately 97% of our equipment base per year. Our gross additions to our equipment base for each of the years ended December 31, 2009 and 2010 through internally generated growth equaled 2%. Our additions, net of lost business, were -2% for the year ended December 31, 2009 and -1% for the year ended December 31, 2010. The machine base not retained is primarily attributable to contracts the Company has chosen not to renew due to unacceptable profit margins (including some acquired contracts that did not meet our performance criteria) and to a lesser degree, to property owners who chose to self-operate. We believe that our ability to maintain the relative size of our equipment base is indicative of our service of, and attention to, property owners and managers. We also provide our customers with proprietary technologies such as LaundryView™, LaundryLinx™, ChangePoint™ and our Client Resource Center, and we continue to invest in research and development of such technologies. We generally have the ability to set and adjust the vend pricing for our equipment based upon local market conditions.
We have centralized our administrative and marketing operations at our corporate headquarters in Waltham, Massachusetts. We also operate sales and/or service centers in Alabama, Arizona (two locations), Colorado, Connecticut, Florida (two locations), Georgia, Illinois, Louisiana, Maine, Maryland, Massachusetts, New Jersey, New Mexico, New York (two locations), North Carolina, Oregon, Tennessee (two locations), Texas (three locations), Utah, Virginia, and Washington.
We also generate revenue by leasing equipment to laundry customers who choose neither to purchase equipment nor to become a laundry facilities management customer, but instead wish to maintain their own laundry rooms. This leasing business generated revenue of $5 million for each of the years ended December 31, 2009 and 2010, and is included in the laundry facilities management business.
Our laundry facilities management business has certain intrinsic characteristics in both its industry and its customer base, including the following:
Revenue. We operate as a laundry facilities management contractor under long-term leases and other arrangements with property owners or managers. Our efforts are designed to maintain these customer relationships over the long-term. Our typical leases have an initial average term of approximately seven years, with the potential to renew if mutually agreed upon by us and the owner or manager. Renewal of a lease usually involves renegotiated terms and new equipment. In each of the past five years, we have retained contracts representing approximately 97% of our equipment base per year.
Customers. As of February 1, 2011, we provided laundry equipment and related services to approximately 86,000 laundry rooms located in 43 states throughout the continental United States and the District of Columbia. As of February 1, 2011, no customer contract accounted for more than 1% of our laundry facilities management revenue. We serve customers in multi-unit housing facilities,
including apartment buildings, college and university residence halls, condominiums, public-housing complexes, military bases and hotels and motels.
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 12% of the laundry facilities management revenue for 2010. Academic facilities management revenue is derived substantially during the school year in the first, second and fourth calendar quarters. Conversely, during the third calendar quarter when most colleges and universities are not in session, the Company increases its operating and capital expenditures when it has its greatest product installation activities in the college market.
Competition. The laundry facilities management industry is highly competitive, capital intensive and requires the delivery of reliable and prompt services to customers. We believe that customers consider a number of factors in selecting a laundry facilities management contractor, such as customer service, reputation, facilities management rent rates (including incentives), advance rents, range of products and services, and technology. We believe that different types of customers assign varied weight to each of these factors and that no one factor alone determines a customer's selection of a laundry facilities management contractor. Within any given geographic area, we may compete with local independent operators, regional and multi-regional operators. The industry is highly fragmented; consequently, we have grown by acquisitions, as well as through new equipment placement. We believe that we are the second largest laundry facilities management contractor in North America.
Impact of Occupancy Rates. Our laundry facilities management revenue is affected by apartment and condominium occupancy rates. Occupancy rates in the multi-unit housing industry are affected by several factors. These factors include local economic conditions, local employment levels, mortgage interest rates as they relate to first-time homebuyers, and the supply of apartments in specific markets. We are somewhat protected from revenue decreases caused by declining occupancy rates due to the variation of markets served, the various types of multi-unit housing facilities therein, and the percentage of revenue derived from colleges and universities. We monitor independent market research data regarding trends in occupancy rates in our markets to better understand laundry facilities revenue trends and variations.
Suppliers. We currently purchase a large majority of the equipment that we use in our laundry facilities management business from Whirlpool Corporation ("Whirlpool".) In addition, we derive a portion of our revenue from our position as a distributor of Whirlpool manufactured appliances. We have maintained a relationship with Whirlpool and its predecessor, Maytag Corporation, since 1927, and either party upon written notice may terminate these agreements. Our relationship with Whirlpool is governed by purchase and distribution agreements and a termination of, or substantial revision of the terms of, the contractual arrangements or business relationships with Whirlpool could have a material adverse effect on the Company's business, results of operations, financial condition and prospects.
Commercial Laundry Equipment Sales Business
Through our commercial laundry equipment sales and services business, we are a significant distributor for several commercial laundry equipment manufacturers, primarily Whirlpool. We do not manufacture any of the commercial laundry equipment that we sell. As an equipment distributor, we sell commercial laundry equipment to public retail laundromats, as well as to the multi-unit housing industry. In addition, we sell commercial laundry equipment directly to institutional purchasers, such as hotels for use in their own on-premise laundry facilities. We are certified by the manufacturers to service the commercial laundry equipment that we sell. Installation and repair services are provided on an occurrence basis, not on a contractual basis. Related revenue is recognized at the time the installation service, or other service, is provided to the customer. For each of the years ended
December 31, 2009 and 2010, our commercial laundry equipment sales business accounted for approximately 5% of our total revenue.
Employee Base
As of February 9, 2011, the Company employed 876 full-time employees. No employee is covered by a collective bargaining agreement and the Company believes that its relationship with its employees is good.
Operating Characteristics
We maintain a corporate staff as well as centralized finance, human resources, legal services, information technology, marketing, and customer service departments. Regionally, we maintain service centers and warehouses staffed by local management, service technicians, collectors, and warehouse personnel.
Backlog
Due to the nature of our laundry facilities management business, backlogs do not exist. There is no significant backlog of orders in our commercial laundry equipment sales business.
Contact Information
We file our annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K with the Securities and Exchange Commission, or "SEC." Our reports filed with the SEC are available at the SEC's website at www.sec.gov and are available free of charge at the Investor Relations section of the Company's website at www.macgray.com as soon as reasonably practicable after filing with the SEC. The information contained on our website is not included as a part of, or incorporated by reference into, this annual report on Form 10-K.
Our corporate offices are located at 404 Wyman Street, Suite 400, Waltham, Massachusetts, 02451-1212. Our telephone number is (781) 487-7600, our fax number is (781) 487-7606, and our email address for investor relations is ir@macgray.com.
Item 1A.
Item 1A. Risk Factors
This annual report on Form 10-K contains statements, some of which are not historical facts and are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements contain projections of our future results of operations or financial position or state other forward-looking information. In some cases you can identify these statements by forward-looking words such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "should," "will" and "would," or similar words. You should not rely on forward-looking statements, because they involve known and unknown risks, uncertainties, and other factors, some of which are beyond our control. These risks, uncertainties, and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by the forward-looking statements. Some of the factors that might cause these differences are as follows:
If we are unable to establish new laundry facility management leases, renew our existing laundry facility management leases or retain relationships with our customers who are not subject to leases, our business, results of operations, cash flows and financial condition could be adversely affected.
Our laundry facilities management business, which provided 95% of our total revenue from continuing operations for the year ended December 31, 2010, is highly dependent upon the renewal of
leases with property owners and property management companies. Approximately 87% of our leases have a weighted average remaining life of 4 years. In the next seven years, 8% to 10% of our laundry room leases are up for renewal each year. We have traditionally relied upon exclusive, long-term leases with our customers, as well as frequent customer interaction and an emphasis on customer service, to assure continuity of financial and operating results. We cannot guarantee that in the future we will be able to establish long-term leases with new customers or renew existing long-term leases as they expire on favorable terms, or at all.
Failure by us to continue to establish long-term leases with new customers, or to successfully renew existing long-term leases as they expire, could have a material adverse effect on our business, results of operations, cash flows and financial condition. Further, approximately 13% of our customers are not subject to leases, are subject to short-term leases of less than one year remaining, or have the right to terminate their lease with us at their option. Failure to retain these customers could have a material adverse effect on our business, results of operations, cash flows and financial condition.
We face strong competition in the outsourced laundry facilities management industry.
The outsourced laundry facilities management industry is highly competitive, and we compete for long-term leases, both locally and nationally, with property owners and other operators in the industry. We compete based on customer service, reputation, facilities management rent rates, incentive payments, and a range of products and services. Smaller local and regional operators typically have long-standing relationships with property owners and managers in their specific geographic market. As such, we may have difficulty penetrating such markets, as property owners and managers may be resistant to terminating such long-standing relationships. We also compete with property owners, as there is no guarantee that property owners will continue to outsource their laundry facilities management to operators. There is one competitor in the industry, Coinmach Corporation, with a larger installed equipment base than us. Competition in the industry may make it more difficult and more expensive to consummate acquisitions in the future and to maintain and expand our installed equipment base. In addition, some of our competitors may have less indebtedness than we do, and therefore more of their cash is potentially available for business purposes other than debt service. We cannot assure you that our results of operations, cash flows or financial condition will not be materially and adversely affected by competition, or that we will be able to maintain our profitability if the competitive environment changes.
If we are unable to continue our relationships with Whirlpool Corporation and other equipment suppliers, our revenues could be reduced, and our ability to meet customer requirements could be materially and adversely affected.
We purchase a large majority of the equipment that we use in our laundry facilities management business from Whirlpool. In addition, we derive a portion of our commercial laundry equipment sales revenue from our position as a distributor of Whirlpool commercial laundry products. Our relationship with Whirlpool is governed by purchase and distribution agreements and a termination of, or substantial revision of the terms of, the contractual arrangements or business relationships with Whirlpool could have a material adverse effect on the Company's business, results of operations, financial condition and prospects. We cannot assure you that Whirlpool will continue its relationship with us. If Whirlpool terminates its relationship with us, our results of operations, cash flows and financial condition could be materially and adversely affected, and further, we may be unable to replace our relationship with Whirlpool with a comparable manufacturer on favorable terms, or at all.
A decrease in multi-unit housing sector occupancy rates in the markets in which we conduct business could adversely affect our laundry facilities management revenue.
Our laundry facilities management revenue from our operation of card- and coin-operated laundry equipment, particularly in the multi-unit housing sector, depends partially upon the level of tenant occupancy. The number of apartments occupied in an apartment building with a vended laundry facility directly affects our revenue. Extended periods of reduced occupancy in our clients' buildings could adversely affect our operations. The level of occupancy can be adversely affected by many market and general economic conditions, all of which are beyond our control, including:
•economic recessions and increases in the unemployment rate;
•increases in foreclosure rates among multi-housing units;
•mortgage interest rates as they apply to first-time homebuyers;
•oversupply of apartments; and
•conversion of apartment units to condominiums with in-unit laundry hookups.
Our cash flows may not be sufficient to finance the significant capital expenditures required to replace equipment, implement new technology, or make incentive payments to property managers.
We must continue to make capital expenditures in order to maintain and replace our installed equipment base and implement new technology in our equipment. We must also make incentive payments to some property managers in order to secure new laundry leases and renew existing laundry leases. We cannot assure you that our resources or cash flows will be sufficient to finance anticipated capital expenditures and incentive payments. To the extent that available resources are insufficient to fund our capital needs, we may need to raise additional funds through public or private financings or curtail certain expenditures. These financings may not be available on favorable terms, or at all, and, in the case of equity financings, could result in dilution to stockholders. If we cannot maintain or replace our equipment as required or implement our new technologies, our results of operations, cash flows and financial condition could be materially and adversely affected.
If we are unable to comply with our debt service requirements under existing or future indebtedness, our indebtedness could become payable immediately.
Our current financing agreements require us to meet certain financial and other covenants. If we are unable to meet those requirements, our indebtedness could become immediately due and payable. If our debt were accelerated we would need to refinance or restructure our debt agreement as our current cash flow would be inadequate to retire our debt, which we may not be able to consummate on commercially reasonable terms, or at all.
If we are unable to access capital on acceptable financial terms, our ability to consummate acquisitions will be limited.
The success of our long-term growth strategy is partially dependent upon our ability to identify, finance and consummate acquisitions on acceptable financial terms. Access to capital is subject to the following risks:
•if we are unable to generate sufficient cash for acquisitions from existing operations, we will not be able to consummate acquisitions unless we are able to obtain additional capital through external financings, which we may not be able to consummate on commercially reasonable terms, or at all;
•funding future acquisitions through debt financings would result in additional leverage;
•the agreements governing our indebtedness include significant limitations on our ability to borrow money for acquisitions and other purposes and, as a result, we may not be able to take advantage of acquisition opportunities;
•use of common stock as acquisition consideration may result in dilution to stockholders; and
•if our common stock does not maintain a sufficient valuation or if potential acquisition candidates are unwilling to accept shares of our common stock, then we would be required to increase our use of cash resources or other consideration to consummate acquisitions.
Acquisitions carry risks that could adversely affect our business.
We have engaged in the past, and intend to engage in the future, in acquisitions to continue the expansion of our laundry facilities management business.
Any future acquisitions could involve numerous risks, including:
•potential disruption of our ongoing business and distraction of management;
•difficulty integrating the operations of the acquired businesses;
•unanticipated expenses related to equipment, maintenance and technology integration;
•exposure to unknown liabilities, including litigation against the companies that we may acquire;
•additional costs due to entering new geographic locations and duplication of key talent;
•potential loss of key employees or customers of the acquired businesses;
•the inability to achieve anticipated synergies or increase the revenue and profit of the acquired business; and
•the expenditure of a disproportionate amount of money and time integrating acquired businesses, particularly operations located in new geographic regions and operations involving new lines of business.
We may not be successful in addressing these risks or any other problems encountered in connection with any acquisitions, which could adversely affect our business, results of operations and financial condition.
Our internal controls over financial reporting may not be adequate and our independent auditors may not be able to certify as to their effectiveness, which could have a significant and adverse effect on our business and reputation.
Section 404 of the Sarbanes-Oxley Act of 2002 requires a reporting company such as ours to, among other things, annually review its internal controls over financial reporting, and evaluate and disclose changes in its internal controls over financial reporting quarterly. If we are not able to achieve and maintain adequate compliance, or our independent auditors are not able to certify as to the effectiveness of our internal control over financial reporting, we may be subject to sanctions or investigation by regulatory authorities, such as the SEC. As a result, there could be an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, we may be required to incur costs in improving our internal control system and the hiring of additional personnel. Any such action could adversely affect our results of operations and financial condition.
Inability to protect our trademarks and other proprietary rights could adversely impact our competitive position.
We rely on patents, copyrights, trademarks, trade secrets, confidentiality provisions, and employee and third party non-disclosure and non-solicitation agreements to establish and protect our intellectual property and proprietary rights. We cannot be certain that steps we have taken to protect our intellectual property and proprietary rights will be adequate or that third parties will not infringe or misappropriate any of our intellectual property or proprietary rights. While we have periodically made filings with the U.S. Patent and Trademark Office, we have traditionally relied upon the protections afforded by contract rights and common law ownership rights, and we cannot assure you that these contract rights and common law ownership rights will adequately protect our intellectual property and proprietary rights. Any infringement or misappropriation of our intellectual property and proprietary rights could damage their value and could have a material adverse effect on our business, results of operations and financial condition. We may have to engage in litigation to protect our rights to our intellectual property and proprietary rights, which could result in significant litigation expenses and require a significant amount of management's time.
We own or license several registered and unregistered trademarks, including Mac-Gray®, Web®, Hof™, Automatic Laundry Company™, Intelligent Laundry®, LaundryView®, LaundryLinx™, PrecisionWash™, TechLinx™, VentSnake™, LaundryAudit™, e-issues™, Change Point®, The Campus Clothes Line™, Digital Laundry is here™, Life Just Got Easier®, and The Laundry Room Experts™ that we use in the marketing and sale of our products. However, the degree of protection that these trademarks afford us is unknown and these trademarks may expire or be terminated. In the event that someone infringes on or misappropriates our trademarks, the brand images and reputation that we have developed could be damaged, which could have a material adverse effect on our business, results of operations and financial condition.
We are dependent on key personnel, and the loss of any of our key personnel could have a material adverse effect on our business, results of operations and financial condition.
Our continued success will depend largely on the efforts and abilities of our executive officers, management teams and other key employees. The loss of any of these officers or other key employees could result in inefficiencies in our operations, lost business opportunities or the loss of one or more customers, which could have a material adverse effect on our business, results of operations and financial condition.
Our financial results have been and could further be negatively impacted by impairments of goodwill or other intangible assets required by the application of existing or future accounting policies or interpretations of existing accounting policies.
The Company assesses goodwill for impairment at least annually and whenever events or circumstances indicate that the carrying amount of the goodwill may be impaired. Important factors that could trigger an impairment review include significant under-performance relative to historical or projected future operating results; significant negative industry or economic trends; and the Company's market capitalization relative to its book value. The Company evaluated its goodwill for impairment as of December 31, 2010 and determined there was no impairment. The goodwill impairment review consists of a two-step process of first assessing the fair value and comparing to the carrying value. If this fair value exceeds the carrying value, no further analysis or goodwill impairment charge is required. If the fair value is below the carrying value, we would proceed to the next step, which is to measure the amount of the impairment loss. The impairment loss is measured as the difference between the carrying value and implied fair value of goodwill. Any such impairment loss would be recognized in the Company's results of operations in the period the impairment loss arose. Any charge could have a significant negative effect on our reported earnings. In addition, our financial results could be
negatively impacted by the application of existing and future accounting policies or interpretations of existing accounting policies.
We face risks associated with environmental regulation.
Our businesses and operations are subject to federal, state and local environmental laws and regulations, including those governing the discharge of pollutants, the handling, generation, storage and disposal of hazardous materials, substances, and wastes and the cleanup of contaminated sites. In connection with current or historical operations by us or at our sites, we could incur substantial costs, including clean-up costs, fines and civil or criminal sanctions, and third-party claims for property damage or personal injury, as a result of violations of, or liabilities under, environmental laws and regulations. While we are not aware of any existing or potential environmental claims against us we cannot guarantee you that we will not in the future incur liability or other costs under environmental laws and regulations that could have a material adverse effect on our business or financial condition.
A small group of stockholders own a substantial percentage of our common stock, and their interests could be in conflict with yours.
As of December 31, 2010, our directors, executive officers, and certain of our stockholders related to such persons and their affiliates beneficially owned in the aggregate approximately 32.4% of the outstanding shares of our common stock. (See Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters" below.) This percentage ownership does not include options to purchase 1,221,393 shares of our common stock held by some of these persons, which options were exercisable at, or within 60 days subsequent to, December 31, 2010. If all of these options had been exercised as of December 31, 2010, then these stockholders and their affiliates would have beneficially owned 37.8% of the outstanding shares of our common stock. Additionally, we are party to a stockholders' agreement with some of these stockholders that gives them rights of first offer to purchase shares of our common stock offered for sale by another stockholder party thereto (See Item 13, "Certain Relationships and Related Transactions" below.) As a result of this concentration in ownership, should these stockholders act together, they have the ability to influence the outcome of the election of directors and all other matters requiring approval by stockholders. Circumstances may arise in which the interests of this group of stockholders could be in conflict with the interests of other stockholders.
Provisions in our charter and bylaws, Delaware law, and shareholder rights plan could have the effect of discouraging takeovers.
Specific provisions of our charter and bylaws, as described below and in Footnote 11 to the Consolidated Financial Statements; sections of the corporate law of Delaware; our shareholder rights plan, and powers of our Board of Directors may discourage takeover attempts not first approved by the Board of Directors, including takeovers which some stockholders may deem to be in their best interests. The shareholder rights plan described below could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, us or a large block of our common stock without the support of our Board of Directors. These provisions and powers of the Board of Directors could delay or prevent the removal of incumbent directors or the assumption of control by stockholders, even if the particular removal or assumption of control would be beneficial to stockholders. These provisions and powers of the Board of Directors could also discourage or make more difficult a merger, tender offer or proxy contest, even if these events would be beneficial, in the short term, to the interests of some shareholders. The anti-takeover provisions and powers of the Board of Directors include, among other things:
•the ability of our Board of Directors to issue shares of preferred stock and to establish the voting rights, preferences and other terms of such preferred stock;
•a classified Board of Directors serving staggered three-year terms;
•the elimination of stockholder voting by written consent;
•the absence of cumulative voting for directors;
•the removal of directors only for cause;
•the vesting of exclusive authority in our Board of Directors to determine the size of the Board of Directors and, subject to the rights of holders of any series of preferred stock, if issued, to fill vacancies thereon;
•the vesting of exclusive authority in our Board of Directors, except as otherwise required by law, to call special meetings of stockholders;
•advance notice requirements for stockholder proposals and nominations for election to the Board of Directors;
•ownership restrictions, under the corporate law of Delaware, with limited exceptions, upon acquirers including their affiliates and associates of 15% or more of its common stock; and
•our adoption of a shareholder rights plan providing for the issuance of rights that will cause substantial dilution to a person or group of persons that acquires 15% or more of the common shares unless the rights are redeemed.
Item 1B.
Item 1B. Unresolved SEC Staff Comments.
None.
Item 2.
Item 2. Properties.
Mac-Gray leases approximately 32,000 square feet in Waltham, Massachusetts that it uses as its corporate headquarters and which houses the Company's administrative and central services. At December 31, 2010, Mac-Gray leased the regional facilities listed below, which are largely operated as
sales and service facilities, although limited administrative functions are also performed at many of them. Mac-Gray also leased storage facilities at various locations.
All properties are primarily utilized for both the laundry facilities management and commercial laundry equipment sales businesses.
We believe that our properties are generally well maintained and in good condition. We believe that our properties are adequate for present needs and that suitable additional or replacement space will be available as required.
Item 3.
Item 3. Legal Proceedings
From time to time, we are a party to litigation arising in the ordinary course of business. There can be no assurance that our insurance coverage will be adequate to cover any liabilities resulting from such litigation. In the opinion of management, any liability that we might incur upon the resolution of currently pending litigation will not, individually or in the aggregate, have a material adverse effect on our business, financial condition, results of operations or cash flows.
Our business and operations are subject to federal, state and local environmental laws and regulations, including those governing the discharge of pollutants, the handling, generation, disposal and storage of hazardous materials and wastes, and the cleanup of contaminated sites. In connection with current or historical operations by us or at our sites, we could incur substantial costs, including clean-up costs, fines and civil or criminal sanctions, and third-party claims for property damage or personal injury, as a result of violations of, or liabilities under, environmental laws and regulations. We believe that our operations are in material compliance with applicable environmental laws and regulations.
Item 4.
Item 4. (Removed and Reserved)
PART II
Item 5.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange, or NYSE, under the symbol "TUC."
The following table sets forth the high and low sales prices for our common stock on the NYSE for the periods indicated.
As of March 7, 2011 there were 109 shareholders of record of our common stock.
On February 5, 2010, the Company's Board of Directors approved the initiation of a quarterly dividend policy for its common stock. The Company had not previously paid dividends on any of its shares of capital stock. The Company declared dividends of $0.05 per share payable on April 1, 2010, July 1, 2010, October 1, 2010 and January 3, 2011. All dividends were paid and have been reflected in the current financial statements.
On January 20, 2011, the Company's Board of Directors approved an increase to the quarterly dividend policy to $0.055 per share ($0.22 per share on an annualized basis).
For information related to our stock option plans and employee stock purchase plans, see Item 12, "Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" below.
Item 6.
Item 6. Selected Financial Data (Dollars in thousands, except per share data)
Set forth below are selected historical financial data as of the dates and for the periods indicated. The selected financial data set forth below should be read in conjunction with, and are qualified by reference to, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements of Mac-Gray and the notes thereto included elsewhere in this report.
(1)Includes the results of operations of the Maryland laundry facilities management assets acquired on August 8, 2007 from Hof Service Company, Inc. for approximately $43,000.
(2)Includes the results of operations of the western and southern region laundry facilities management assets acquired on April 1, 2008 from Automatic Laundry Company, Ltd. for approximately $116,000.
(3)EBITDA from continuing operations is defined as income from continuing operations before provision for income taxes, depreciation and amortization expense and interest expense. EBITDA from continuing operations and Adjusted EBIDTA from continuing operations are included in this report because they are a basis upon which our management and Board of Directors assess our operating performance. EBITDA from continuing operations is not a measure of our liquidity or financial performance under GAAP and should not be considered as an alternative to net income or any other performance measure derived in accordance with GAAP, or as an alternative to cash flows from operating activities as a measure of our liquidity. The use of EBITDA from continuing operations instead of net income has limitations as an analytical tool, including the exclusion of interest expense and depreciation and amortization expense, which represent significant and unavoidable operating costs given the level of indebtedness and the capital expenditures needed to maintain our business. Management compensates for these limitations by relying primarily on our GAAP results and by using EBITDA from continuing operations only supplementally. Our management believes EBITDA from continuing operations is useful to investors because it helps enable investors to evaluate our business in the same manner as our management and because it is frequently used by securities analysts, investors and other interested parties in the evaluation of companies with substantial financial leverage. Our measure of EBITDA from continuing operations is not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the methods of calculation.
(4)Excludes $1,776, $2,003, $1,774, $1,628 and $2,421 in 2006, 2007, 2008, 2009, and 2010 respectively, of capital leases associated with vehicles acquired and used in the operation of the Company.
The following is a reconciliation of income (loss) from continuing operations to EBITDA from continuing operations and Adjusted EBITDA from continuing operations:
(1)Includes the results of operations of the Maryland laundry facilities management assets acquired on August 8, 2007 from Hof Service Company, Inc. for approximately $43,000.
(2)Includes the results of operations of the western and southern region laundry facilities management assets acquired on April 1, 2008 from Automatic Laundry Company, Ltd. for approximately $116,000.
(3)EBITDA from continuing operations is defined as income from continuing operations before provision for income taxes, depreciation and amortization expense and interest expense. Adjusted EBITDA from continuing operations is EBITDA from continuing operations further adjusted to exclude the items described in the table above. We have excluded these items because we believe they are not reflective of our ongoing operating performance. EBITDA from continuing operations and Adjusted EBIDTA from continuing operations are included in this report because they are a basis upon which our management and Board of Directors assess our operating performance. EBITDA from continuing operations and Adjusted EBITDA from continuing operations are not measures of our liquidity or financial performance under GAAP and should not be considered as alternatives to net income or any other performance measure derived in accordance with GAAP, or as an alternative to cash flows from operating activities as a measure of our liquidity. The use of EBITDA from continuing operations and Adjusted EBITDA from continuing operations instead of net income has limitations as an analytical tool, including the exclusion of interest expense and depreciation and amortization expense, which represent significant and unavoidable operating costs given the level of indebtedness and the capital expenditures needed to maintain our business. Management compensates for these limitations by relying primarily on our GAAP results and by using EBITDA from continuing operations and Adjusted EBITDA from continuing operations only supplementally. Our management believes EBITDA from continuing operations and Adjusted
EBITDA from continuing operations are useful to investors because they help enable investors to evaluate our business in the same manner as our management and because they are frequently used by securities analysts, investors and other interested parties in the evaluation of companies with substantial financial leverage. Our measures of EBITDA from continuing operations and Adjusted EBITDA from continuing operations are not necessarily comparable to other similarly titled captions of other companies due to potential inconsistencies in the methods of calculation.
(4)Represents a pre-tax charge associated with our former reprographics business unit.
(5)The (gain) loss related to derivative instruments is the consequence of interest rate swaps which do not qualify for hedge accounting treatment. For interest rate swaps that do qualify as hedged instruments, changes in fair value are recorded in Other Comprehensive Income and not in the income statement. Including the fluctuation in the fair value of the derivative instruments in the reconciliation of net income as reported to net income as adjusted allows for a more consistent comparison of the operating results of the Company. The fair value of the derivatives is ultimately zero at the time of settlement provided that the Company holds the contract through the date of maturity. Thus, over the life of the derivative instruments the net impact of the unrealized gain or loss to the Company's operating results will ultimately be zero as any income or loss recorded in prior periods will be offset in subsequent periods if the contract is held to its maturity date. However the Company will be impacted by the realized settlements of the derivative instruments on a quarterly basis.
(6)Each of the losses on early extinguishment of debt resulted from separate and distinct refinancings of our senior credit facility in 2006 and 2008 and is not related to the performance of the Company's business. Each of the losses reflects only the unamortized cost of the prior bank financing which had been allocated to banks which did not participate in the replacement financing agreement. Because the losses were triggered by refinancings of our senior credit facility and the Company does not currently expect further refinancings of the facility prior to its maturity in 2013, management believes that the impact of this item on the Company's financial results will not continue beyond 2008.
(7)Represents a pretax gain recognized in connection with the sale of a facility in Tampa, Florida on January 2, 2009.
(8)Interest expense, net, does not include the change in the fair value of non-hedged derivative instruments.
(9)Represents additional costs incurred for legal advice and proxy solicitation in response to proxy contests relating to the Company's 2009 and 2010 annual meetings.
(10)Includes the loss on disposal of discontinued operations of $294, net of tax.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Continuing Operations. (Dollars in thousands)
The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes thereto presented elsewhere in this report.
This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. 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, without limitation, the factors described under Item 1A "Risk Factors."
Our actual results, performance or achievement 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.
Overview
Mac-Gray was founded in 1927 and re-incorporated in Delaware in 1997. We derive our revenue principally as a laundry facilities management contractor for the multi-unit housing industry. We also derive revenue through the sales of commercial laundry equipment primarily to public retail laundromats, as well as to the multi-unit housing industry. In addition, we sell commercial laundry equipment directly to institutional purchasers such as hotels, for use in their own on-premise laundry facilities. Our core 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 years ended December 31, 2009 and 2010, our total revenue was $325,924 and $320,011, respectively. Approximately 95% of our total revenue for these periods was generated by our laundry facilities management business. We generate laundry facilities management revenue primarily through long-term leases with property owners or property management companies granting us 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 December 31, 2010, approximately 87% of our installed machine base was located in laundry facilities subject to long-term leases, with 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/or expenses to refurbish laundry facilities. Our capital expenditures consist of a large number of relatively small amounts associated with our entry into or renewal of leases. Accordingly, our capital needs are predictable and largely within our control. For the years ended December 31, 2009 and 2010, we incurred $21,341 and $26,580 of capital expenditures, respectively. In addition, we make incentive payments to property owners and property management companies to secure our lease arrangements. We paid $1,807 and $3,045 in incentive payments in the years ended December 31, 2009 and 2010, respectively.
In addition, through our Commercial Laundry Equipment Sales business, we generate revenue by selling commercial laundry equipment. For the years ended December 31, 2009 and 2010, our Commercial Laundry Equipment Sales business accounted for approximately 5% of our total revenue for both 2009 and 2010, and 6% and 5% of our gross margin for 2009 and 2010, respectively. We
anticipate that tight credit markets for our customers will continue to challenge our ability to maintain or grow our revenue from laundry equipment sales.
Our financial objective is to maintain and enhance profitability by retaining existing customers, adding customers in areas in which we currently operate, selectively expanding our geographic footprint and density through acquisitions, and controlling costs. One of the key challenges we face is maintaining and expanding our customer base in a competitive industry. We experience competition from other industry participants, including national, regional and local laundry facilities management operators and from property owners and property management companies who self-operate their laundry facilities. We devote substantial resources to our marketing and sales efforts and we focus on continued innovation in order to distinguish us from competitors. Apartment vacancy rates pose an additional challenge. We have begun to see some improvement in vacancy rates; however we expect vacancy rates above the historical norm to continue to have a negative impact, but to a lesser extent than in prior years, on our laundry facilities management business in 2011. Approximately 8% to 10% of our laundry room leases are up for renewal each year. Over the past five calendar years, we have been able to retain, on average, approximately 97% of our total installed equipment base each year. Our gross additions to our equipment base for each of the years ended December 31, 2009 and 2010 through internally generated growth equaled 2%. Our additions, net of lost business, were -2% for the year ended December 31, 2009 and -1% for the year ended December 31, 2010. The machine base not retained is primarily attributable to contracts we have has chosen not to renew due to unacceptable profit margins, (including some acquired contracts that did not meet our performance criteria,) and to a lesser degree, to property owners who chose to self-operate.
On January 4, 2010, we entered into an interest rate swap agreement to manage the interest rate risk associated with our debt. The swap agreement effectively converts a portion ($100 million) of our fixed rate senior notes to a variable rate. Under this agreement, we receive the fixed rate on our senior notes (7.625%) and pay a variable rate of LIBOR plus the applicable margin charged by the banks. This swap agreement has an associated call feature that allows the counterparty to terminate this agreement at their option.
On February 5, 2010, the Company sold its MicroFridge® (Intirion Corporation) business to Danby Products. The transaction was valued at approximately $11,500. Danby Products paid $8,500 in cash, and assumed existing liabilities and financial obligations of MicroFridge totaling approximately $3,000. Our discontinued operations are related solely to the sale of MicroFridge® (Intirion Corporation). Concurrent with this transaction, we paid $8,000 on our Secured Term Loan.
On February 5, 2010, our Board of Directors approved the initiation of a quarterly dividend policy for our common stock. We had not previously paid dividends on any of our shares of capital stock. We paid aggregate dividends of $0.20 per share in 2010.
On January 20, 2011, the Company's Board of Directors approved an increase to the quarterly dividend policy to $0.055 per share ($0.22 per share on an annualized basis).
Results of Continuing Operations (Dollars in thousands, except per share data)
On February 5, 2010, we sold our MicroFridge® (Intirion Corporation) business to Danby Products. The following discussion excludes the financial results from our discontinued operations unless otherwise noted. The information presented below for the years ended December 31, 2009 and 2010 is derived from our consolidated financial statements and related notes included in this report.
Revenue from continuing operations
Fiscal year ended December 31, 2010 compared to fiscal year ended December 31, 2009
Total revenue decreased by $5,913 or 2%, to $320,011 for the year ended December 31, 2010 compared to $325,924 for the year ended December 31, 2009.
Laundry facilities management revenue. Laundry facilities management revenue decreased by $4,988, or 2%, to $304,040 for the year ended December 31, 2010 compared to $309,028 for the year ended December 31, 2009. The decrease in revenue is attributable to the termination of contracts we have chosen not to renew, the decision of some customers to operate their own laundry rooms and reduced usage of our equipment in apartment building laundry rooms as a result of the continued level of higher apartment vacancy rates in some markets. These decreases are partially offset by our ability to add new contracts and our vend increase program. We have begun to see some decrease in vacancy rates; however we expect vacancy rates above the historical norm to continue to have a negative impact, but to a lesser extent than in prior years, on our laundry facilities management business in 2011. We 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. Revenue in the commercial laundry equipment sales business decreased $925, or 5%, to $15,971 for the year ended December 31, 2010 compared to $16,896 for the year ended December 31, 2009. Sales in the commercial laundry equipment sales business are sensitive to the strength of the local economy, consumer confidence, local permitting, and the availability and cost of financing to small businesses, and therefore, tend to fluctuate from period to period. We anticipate that tight credit markets for our customers will continue to challenge our ability to maintain or grow our revenue from laundry equipment sales in 2011.
Cost of revenue
Cost of laundry facilities management revenue. Cost of laundry facilities management revenue includes rent paid to customers as well as costs associated with installing and servicing machines, costs of collecting, counting, and depositing facilities management revenue and the costs of delivering and servicing rented facilities management equipment. Cost of laundry facilities management revenue decreased $773, or less than 1%, to $208,141 for the year ended December 31, 2010, as compared to $208,914 for the year ended December 31, 2009. The decrease is due primarily to decreased rent paid to customers as a result of lower revenues. These decreases were offset by higher transportation costs and branch operating expenses. As a percentage of facilities management revenue, cost of facilities management revenue was 68% for each of the years ended December 31, 2010 and 2009. Facilities management rent as a percentage of facilities management revenue was 49% and 48% for the years ended December 31, 2010 and 2009, respectively. Facilities management rent can be affected by new and renewed laundry leases, lease portfolios acquired 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 facilities management rent as a function of facilities
management revenue can vary. Incentive payments and laundry room betterments are amortized over the life of the related lease.
Depreciation and amortization related to operations. Depreciation and amortization related to operations decreased by $2,253, or 5%, to $46,013 for the year ended December 31, 2010 as compared to $48,266 for the year ended December 31, 2009. The decrease in depreciation and amortization for the year ended December 31, 2010 as compared to the same period in 2009 is primarily attributable to the fact that most of the equipment we acquired as part of the acquisitions we made in 2004 and 2005 was fully depreciated in 2009. The pool of equipment we acquired was assigned an average life of 5 years.
Cost of commercial 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 $547, or 4%, to $13,105 for the year ended December 31, 2010 as compared to $13,652 for the year ended December 31, 2009. As a percentage of sales, cost of commercial laundry equipment sales was 82% for the year ended December 31, 2010 compared to 81% in 2009. The gross margin in the commercial laundry equipment sales business unit decreased to 18% for the year ended December 31, 2010 as compared to 19% for the same period in 2009. The change in gross margin from period to period is primarily a function of the mix of products sold.
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 $58, or less than 1%, to $34,581 for the year ended December 31, 2010 as compared to $34,639 for the year ended December 31, 2009. As a percentage of total revenue, these expenses were 11% for the years ended December 31, 2010 and 2009. The decrease in expenses for the year ended December 31, 2010 as compared to December 31, 2009 is primarily attributable to a reduction in professional fees.
Gain on sale of assets. The gain on sale of assets is primarily attributable to the gain on the sale of our facility in Tampa, Florida in 2009. It had been our objective to sell all operating facilities and property, thus increasing our flexibility relating to facility costs and locations. The sale of the Tampa facility completed the disposal of Company owned properties. Gain on sale of assets also includes the gain from the sale of vehicles and other non-inventory assets in the ordinary course of business.
Income from continuing operations.
Income from continuing operations decreased by $2,668, or 13%, to $18,433 for the year ended December 31, 2010 as compared to $21,101 for the year ended December 31, 2009. Excluding the gain on sale of real estate in 2009, income from continuing operations, as adjusted, decreased by $2,265 or 11% from $20,698 for the year ended December 31, 2009, to $18,433 for the year ended 2010. We have supplemented the consolidated financial statements presented according to generally accepted accounting principles (GAAP), using a non-GAAP financial measure of adjusted income from continuing operations. Non-GAAP financial measures are not in accordance with, or an alternative for, generally accepted accounting principles in the United States. Our non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP financial measures, and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP. Management believes presentation of this measure is useful to investors to enhance an overall understanding of our historical financial performance and future prospects. Adjusted income from continuing operations, which is adjusted to exclude certain gains and losses from the comparable GAAP income from operations, is an indication of our baseline performance before
gains, losses or other charges that are considered by management to be outside of our core operating results. The presentation of this additional information is not meant to be considered in isolation or as a substitute for income from operations or other measures prepared in accordance with GAAP.
A reconciliation of income from continuing operations in accordance with GAAP to income from operations, as adjusted, is provided below:
(1)Represents a pretax gain recognized in connection with the sale of a facility in Tampa, Florida on January 2, 2009.
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, decreased by $5,354, or 29%, to $13,428 for the year ended December 31, 2010 as compared to $18,782 for the year ended December 31, 2009. The decrease is due to lower outstanding debt balances attributable to operations generating free cash flow, the $8,000 reduction in debt from the proceeds of the February 5, 2010 sale of Intirion Corporation, the interest rate savings achieved from the fixed to floating interest rate swap agreement we entered into during the first quarter of 2010, and the increase in the unrealized gain on interest rate protection contracts which do not qualify for hedge accounting. Interest expense, excluding the change in fair value of non-hedged derivative instruments was $14,882 and $19,675 for the years ended December 31, 2010 and 2009, respectively. Our average effective interest rates are not significantly affected by fluctuations in the market as a significant amount of our debt have fixed rates through our derivative instruments. Our average effective borrowing rate was 6.1% for the year ended December 31, 2010 as compared to 7.1% for the year ended December 31, 2009.
We are party to interest rate swap agreements which we entered into to hedge the interest rates on our debt. Certain of these swap agreements do not qualify as cash flow hedges. In accordance with the guidelines for accounting for derivatives, non-cash gains of $1,454 and $893 have been recorded in the income statement for the years ended December 31, 2010 and 2009, respectively.
Provision for income taxes
The provision for income taxes increased by $898, or 70%, to $2,176 for the year ended December 31, 2010 compared to an expense of $1,278 for the year ended December 31, 2009. The increase is primarily the result of increased income before the provision for income taxes in 2010 compared to the income before provision for income taxes in 2009. The effective tax rate for 2010 is 43.4%. The effective tax rate is comprised of the federal statutory rate of 34%, the state rate net of federal taxes of 6.9%, permanent book/tax differences of 3.5% and changes to deferred rates and valuation reserves of -1%. The most significant reductions of the effective tax rate in 2010 compared to 2009 are lower state income taxes as a percentage of pretax income and a smaller change to the valuation allowance.
Income from continuing operations, net
As a result of the foregoing, income from continuing operations, net, increased by $1,788 to $2,829 for the year ended December 31, 2010 as compared to $1,041 for the year ended December 31, 2009. Income from continuing operations, net, as adjusted for the items in the table below, increased by $1,245 to $2,140 for the year ended December 31, 2010 as compared to $895 for the year ended December 31, 2009.
A reconciliation of income from continuing operations, net, as reported to income from continuing operations, net, as adjusted is provided below:
(1)Represents the unrealized gain on interest rate protection contracts, which do not qualify for hedge accounting treatment. For interest rate swaps that do qualify as hedged instruments, changes in mark to market are recorded in Other Comprehensive Income and not in the income statement. Including the fluctuation in the fair value of the derivative instruments in the reconciliation of net income as reported to net income as adjusted allows for a more consistent comparison of the operating results of the Company.
(2)Represents the sale of a facility in Tampa, Florida on January 2, 2009.
(3)Represents additional costs incurred for legal advice and proxy solicitation in response to proxy contests relating to our 2009 and 2010 annual meetings.
To supplement the Company's consolidated financial statements presented on a generally accepted accounting principles (GAAP) basis, management has used a non-GAAP measure of net income. Management believes presentation of this measure is appropriate to enhance an overall understanding of our historical financial performance and future prospects. Adjusted income from continuing operations, net, which is adjusted to exclude certain gains and losses from the comparable GAAP income from continuing operations, net is an indication of our baseline performance before gains, losses or other charges that are considered by management to be outside of our core operating results. These non-GAAP results are among the primary indicators management uses as a basis for evaluating the Company's financial performance as well as for forecasting future periods. For these reasons, management believes these non-GAAP measures can be useful to investors, potential investors and others.
Non-GAAP financial measures are not in accordance with, or an alternative for, generally accepted accounting principles in the United States. The Company's non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP financial measures, and should be read only in conjunction with the Company's consolidated financial statements prepared in accordance with GAAP.
Income from Discontinued Operations, net
Income from discontinued operations, net, excluding the loss on disposal of $294, decreased to $44 for the year ended December 31, 2010 as compared to $1,074 for the year ended December 31, 2009. Revenue from the discontinued operation decreased to $2,200 for the year ended December 31, 2010 as compared to $30,298 for the year ended December 31, 2009.
Fiscal year ended December 31, 2009 compared to fiscal year ended December 31, 2008
The information presented below for the years ended December 31, 2008 and 2009 is derived from Mac-Gray's consolidated financial statements and related notes included in this report.
Revenue from continuing operations
Total revenue decreased by $1,305 or less than 1%, to $325,924 for the year ended December 31, 2009 compared to $327,229 for the year ended December 31, 2008.
Laundry facilities management revenue. Laundry facilities management revenue increased by $2,939, or 1%, to $309,028 for the year ended December 31, 2009 compared to $306,089 for the year ended December 31, 2008. The increase in revenue is the net of an increase of $10,682 attributable to the laundry facilities management businesses acquired in 2008, offset by a decline of $7,743 resulting from reduced usage of the Company's equipment in apartment building laundry rooms as a result of increased apartment vacancy rates in some markets. To a lesser extent, the decrease in revenue is attributable to the termination of contracts we have chosen not to renew, partially offset by the Company's vend increase program. We expect vacancy rates to continue to have a negative impact on our facilities management business in 2010. We 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. Revenue in the commercial laundry equipment sales business decreased $4,244, or 20%, to $16,896 for the year ended December 31, 2009 compared to $21,140 for the year ended December 31, 2008. One single transaction accounted for $1,718, or 8% of the revenue in 2008. Sales in the commercial laundry equipment sales business are sensitive to the strength of the local economy, consumer confidence, local permitting and the availability and cost of financing to small businesses, and therefore, tend to fluctuate from period to period. We anticipate that tight credit markets will continue to make obtaining financing a challenge for some potential customers.
Cost of revenue
Cost of laundry facilities management revenue. Cost of laundry facilities management revenue includes rent paid to customers as well as costs associated with installing and servicing machines, costs of collecting, counting, and depositing laundry facilities management revenue and the costs of delivering and servicing rented facilities management equipment. Cost of laundry facilities management revenue increased $1,681, or 1%, to $208,914 for the year ended December 31, 2009, as compared to $207,233 for the year ended December 31, 2008. The increase is due primarily to the $803 increased rent associated with the increase in laundry facility management revenue resulting from the facilities management business we acquired from Automatic Laundry Company, Ltd. ("ALC") on April 1, 2008 as well as increased employee health insurance costs of $1,590. These increases were offset by cost control measures implemented by the Company. As a percentage of laundry facilities management revenue, cost of laundry facilities management revenue was 68% for each of the years ended December 31, 2009 and 2008. Facilities management rent as a percentage of laundry facilities management revenue was 48% and 49% for the years ended December 31, 2009 and 2008, respectively. Laundry facilities management rent can be affected by new and renewed laundry leases, lease portfolios acquired 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. Incentive payments and betterments are amortized over the life of the related lease.
Depreciation and amortization related to operations. Depreciation and amortization related to operations increased by $1,105, or 2%, to $48,266 for the year ended December 31, 2009 as compared to $47,161 for the year ended December 31, 2008. The increase in depreciation and amortization for the year ended December 31, 2009 as compared to the same period in 2008 is primarily attributable to having a full year of depreciation and amortization in 2009 associated with the contract rights and equipment we acquired as part of our acquisition of a laundry facilities management business on April 1, 2008 compared to only nine months of such depreciation and amortization in the comparable period in 2008. Laundry facilities management equipment and contract rights are depreciated and amortized using the straight-line method. In addition, due to management's decision not to recondition and redeploy equipment that is in need of significant repairs and is not as energy efficient as newer equipment, we disposed of certain laundry equipment in 2009 and 2008 that had a remaining net book value of $662 and $642, respectively. These costs are included in depreciation expense.
Cost of commercial 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 $3,635, or 21%, to $13,652 for the year ended December 31, 2009 as compared to $17,287 for the year ended December 31, 2008. As a percentage of sales, cost of commercial laundry equipment sales was 81% for the year ended December 31, 2009 compared to 82% in 2008. The gross margin in the commercial laundry equipment sales business unit increased to 19% for the year ended December 31, 2009 as compared to 18% for the same period in 2008. The change in gross margin from period to period is primarily a function of the mix of products sold.
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 $286, or 1%, to $34,639 for the year ended December 31, 2009 as compared to $34,925 for the year ended December 31, 2008. Such decrease for the year ended December 31, 2009 includes incremental costs of our proxy contest of $971. Excluding these costs, the decrease would have been $1,257. As a percentage of total revenue these expenses were 11% for the years ended December 31, 2009 and 2008. The decrease in expenses for the year ended
December 31, 2009 as compared to December 31, 2008 is primarily attributable to a reduction in professional fees and outside services.
Loss on early extinguishment of debt. Effective April 1, 2008 and in conjunction with our acquisition of ALC, we amended our bank credit facilities. As a result of this amendment, a portion of the unamortized financing costs amounting to $207, which had been incurred as part of the prior credit facility, was expensed in 2008.
Gain on sale of assets. The gain on sale of assets is primarily attributable to the gain on the sale of our facility in Tampa, Florida in 2009. It has been our objective to sell all operating facilities and property, thus increasing our flexibility relating to facility costs and locations. The sale of the Tampa facility completes the disposal of Company owned properties. Gain on sale of assets also includes the gain from the sale of vehicles and other non-inventory assets in the ordinary course of business.
Income from continuing operations
Income from continuing operations increased by $616, or 3%, to $21,101 for the year ended December 31, 2009 as compared to $20,485 for the year ended December 31, 2008. Excluding loss on early extinguishment of debt and the gain on sale of real estate, income from continuing operations, as adjusted, would have been $20,692 for the year ended December 31, 2008, compared to $20,698 for the year ended 2009. We have supplemented the consolidated financial statements presented according to generally accepted accounting principles (GAAP), using a non-GAAP financial measure of adjusted income from continuing operations. Non-GAAP financial measures are not in accordance with, or an alternative for, generally accepted accounting principles in the United States. The Company's non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP financial measures, and should be read only in conjunction with the Company's consolidated financial statements prepared in accordance with GAAP. Management believes presentation of this measure is useful to investors to enhance an overall understanding of our historical financial performance and future prospects. Adjusted income from continuing operations, which is adjusted to exclude certain gains and losses from the comparable GAAP income from operations, is an indication of our baseline performance before gains, losses or other charges that are considered by management to be outside of our core operating results. The presentation of this additional information is not meant to be considered in isolation or as a substitute for income from operations or other measures prepared in accordance with GAAP.
A reconciliation of income from continuing operations in accordance with GAAP to income from operations, as adjusted, is provided below:
(1)The loss on early extinguishment of debt resulted from a refinancing of our senior credit facility and is not related to the performance of the Company's business. The loss reflects only the unamortized cost of the prior bank financing which had been allocated to banks which did not participate in the replacement financing agreement. Because the loss was triggered by a refinancing of the Company's senior credit facility and the Company does not currently expect further refinancings of the facility prior to its maturity in 2013, management believes that the impact of this item on the Company's financial results will not continue beyond 2008.
(2)Represents a pretax gain recognized in connection with the sale of a facility in Tampa, Florida on January 2, 2009.
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, decreased by $3,627, or 16%, to $18,782 for the year ended December 31, 2009 as compared to $22,409 for the year ended December 31, 2008. The decrease is due to lower outstanding debt balances resulting from our concerted effort to reduce interest-bearing debt. Included in interest expense for the year ended December 31, 2008 is nine months interest on our debt resulting from the April, 2008 ALC acquisition. Included in the year ended December 31, 2009 is twelve months interest on our debt resulting from the ALC acquisition. Interest expense, excluding the change in the fair value of non-hedged derivative instruments, was $19,675 and $20,605 for the years ended December 31, 2009 and 2008, respectively. Our average effective interest rates are not significantly affected by fluctuations in the market as a significant amount of our debt have fixed rates through our derivative instruments. Our average effective borrowing rate was 7.1% for the year ended December 31, 2009 as compared to 6.7% for the year ended December 31, 2008.
We are party to interest rate swap agreements which we entered into to hedge the interest rates on our debt. Certain of these swap agreements do not qualify as cash flow hedges. In accordance with the guidelines for accounting for derivatives, a non-cash gain of $893 and a non-cash loss of $1,804 have been charged to the income statement for the years ended December 31, 2009 and 2008, respectively.
Provision for income taxes
The provision for income taxes increased by $2,036, to an expense of $1,278 for the year ended December 31, 2009 compared to a benefit of $758 for the year ended December 31, 2008. The increase is primarily the result of positive income before the provision for income taxes in 2009 compared to a loss before the provision for income taxes in 2008. The effective tax rate for 2009 is 55.1%. The effective tax rate is comprised of the federal statutory rate of 34%, the state rate net of federal taxes of 11.7%, permanent book/tax differences of 6.4% and changes to deferred rates and valuation reserves of 3.0%. The effective tax rate of 39.4% in 2008 was favorably impacted by an amendment to Massachusetts tax laws which reduced the Company's provision for income taxes by $198 and the release of reserves for uncertain tax positions of $204 in conjunction with the completion of the Internal Revenue Service tax audits through 2005.
Income from continuing operations, net
As a result of the foregoing, income from continuing operations, net, increased by $2,207 to $1,041 for the year ended December 31, 2009 as compared to a loss of $1,166 for the year ended December 31, 2008. Income from continuing operations, net, as adjusted for the items in the table below, increased by $842 to $895 for the year ended December 31, 2009 as compared to $53 for the year ended December 31, 2008.
A reconciliation of income from continuing operations, net, as reported to income from continuing operations, net, as adjusted is provided below:
(1)Represents the unrealized loss (gain) on interest rate protection contracts, which do not qualify for hedge accounting treatment. For interest rate swaps that do qualify as hedged instruments, changes in mark to market are recorded in Other Comprehensive Income and not in the income statement. Including the fluctuation in the fair value of the derivative instruments in the reconciliation of net income as reported to net income as adjusted allows for a more consistent comparison of the operating results of the Company.
(2)The loss on early extinguishment of debt resulted from a refinancing of our senior credit facility and is not related to the performance of the Company's business. The loss reflects only the unamortized cost of the prior bank financing which had been allocated to banks which did not participate in the replacement financing agreement. Because the loss was triggered by a refinancing of the Company's senior credit facility and the Company does not currently expect further refinancings of the facility prior to its maturity in 2013, management believes that the impact of this item on the Company's financial results will not continue beyond 2008.
(3)Represents the sale of a facility in Tampa, Florida on January 2, 2009.
To supplement the Company's consolidated financial statements presented on a generally accepted accounting principles (GAAP) basis, management has used a non-GAAP measure of net income. Management believes presentation of this measure is appropriate to enhance an overall understanding of our historical financial performance and future prospects. Adjusted income from continuing operations, net, which is adjusted to exclude certain gains and losses from the comparable GAAP income from continuing operations, net is an indication of our baseline performance before gains, losses or other charges that are considered by management to be outside of our core operating results. These non-GAAP results are among the primary indicators management uses as a basis for evaluating the Company's financial performance as well as for forecasting future periods. For these reasons, management believes these non-GAAP measures can be useful to investors, potential investors and others.
Non-GAAP financial measures are not in accordance with, or an alternative for, generally accepted accounting principles in the United States. The Company's non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable GAAP financial measures, and should be read only in conjunction with the Company's consolidated financial statements prepared in accordance with GAAP.
Income from Discontinued Operations, net
Income from discontinued operations decreased by $633, or 37%, to $1,074 for the year ended December 31, 2009 as compared to $1,707 for the year ended December 31, 2008. Revenue from the discontinued operation decreased by $6,066 to $30,298 for the year ended December 31, 2009 as compared to $36,364 for the year ended December 31, 2008.
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 under our revolving loan 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. Included in the capital requirements that we expect to be able to fund during 2011 are purchases of new laundry equipment, laundry room betterments, and contract incentives incurred 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 our 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.
From time to time, we consider potential acquisitions. We believe that any future acquisitions of significant size would likely require us to obtain additional debt or equity financing. In the past, we have been able to obtain such financing for other material transactions on terms that we believed to be reasonable. However, the availability of such funds depends in large measure on credit and capital markets and other factors outside our control. It is possible that we may not be able to obtain acquisition financing on reasonable terms, or at all, in the future.
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 operations will be sufficient to repay our long-term debt when it comes due. We anticipate that we will need to refinance some portion of our indebtedness or otherwise amend its terms when it reaches maturity. We cannot make any assurances that such financing would be available on reasonable terms, if at all.
Operating Activities
For the years ended December 31, 2008, 2009 and 2010, cash flows provided by operating activities from continuing operations were $55,735, $60,720, and $54,080 respectively. Cash flows from operations consist primarily of facilities management revenue and equipment sales, offset by the cost of facilities management revenues, cost of product sold, and selling, general and administration expenses. The most significant changes to cash flows in 2010 compared to 2009 were decreases in depreciation and amortization expense and related deferred taxes, an increase in accounts receivable, a decrease in the change in accounts payable, accrued facilities management rent, accrued expenses and an increase in non-cash derivative income. The decrease in depreciation and amortization expense and related deferred income taxes is primarily attributable to the fact that most of the equipment from our acquisitions in 2004 and 2005 was fully depreciated in 2009.
Investing Activities
For the years ended December 31, 2008, 2009 and 2010, cash flows used in investing activities from continuing operations were $130,111, $20,074, and $25,973 ,respectively. Included in the cash flows used in investing activities is a payment for acquisition of $106,213 in 2008. and the proceeds from the sale of Intirion Corporation of $8,274 in 2010. Other capital expenditures for the years ended December 31, 2008, 2009, and 2010 totaled $24,313, $21,341, and $26,580, respectively. We realized additional cash flows from the proceeds received from the disposal of our discontinued operation of $8,274.
Financing Activities
For the years ended December 31, 2008, 2009 and 2010, cash flows provided by (used in) financing activities from continuing operations were $79,887, ($37,883), and ($36,673), respectively. Cash flows provided by financing activities consist primarily of borrowings to fund acquisitions. Cash flows used in financing activities consist primarily of repayments of bank borrowings. We also paid $8,000 on our term loan from the proceeds we received from the disposal of our discontinued operation. In 2010, we also paid cash dividends of $2,763.
The Company has a senior secured credit agreement (the "Secured Credit Agreement") pursuant to which the Company may borrow up to $151,750 in the aggregate, including $21,750 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 there under, 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 the Company's senior secured leverage ratio.
The obligations under the Secured Credit Agreement are guaranteed by the Company's subsidiaries and secured by (i) a pledge of 100% of the ownership interests in the subsidiaries, and (ii) a first-priority security interest in substantially all of 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 December 31, 2010.
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 December 31, 2010, there was $50,353 outstanding under the Revolver, $21,750 outstanding under the Term Loan and $1,380 in outstanding letters of credit. The available balance under the Revolver was $78,267 at December 31, 2010. The average interest rates on the borrowings outstanding under the Secured Credit Agreement at December 31, 2009 and 2010 were 6.69% and 5.56%, respectively, including the applicable spread paid to the banks.
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. 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 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:
As of December 31, 2010, the Company had not redeemed any of its senior notes.
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 December 31, 2010.
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 December 31, 2010.
Capital lease obligations on the Company's fleet of vehicles totaled $3,276 and $3,833 at December 31, 2009 and 2010, respectively.
Required payments under the Company's long-term debt and capital lease obligations are as follows:
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, corporate headquarters and warehouse rent and minimum facilities management rent as of December 31, 2010 is as follows:
Off Balance Sheet Arrangements
At the years ended December 31, 2008, 2009 and 2010, we had no relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or variable interest entities, which would have been established for the purpose of facilitating off balance sheet arrangements, or other contractually narrow or limited purposes.
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 12% of our total laundry facilities management revenue in 2010. 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 in the college market while colleges and universities are on summer break.
Inflation
We do not believe that our financial performance has been materially affected by inflation.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements in accordance with GAAP requires management to make judgments, assumptions and estimates that affect the amounts reported. A critical accounting estimate is an assumption about highly uncertain matters and could have a material effect on the consolidated financial statements if another, also reasonable, amount was used or a change in the estimate is reasonably likely from period to period. We base our assumptions on historical experience and on other estimates that we believe are reasonable under the circumstances. Actual results could differ significantly from these estimates.
Our critical accounting policies, as described in Note 2 to the Mac-Gray audited consolidated financial statements included elsewhere in this report, "Significant Accounting Policies," state our policies as they relate to significant matters: cash and cash equivalents, revenue recognition, provision for doubtful accounts, inventories, provision for inventory reserves, goodwill and intangible assets, impairment of long-lived assets, financial instruments and fair value of financial instruments.
Cash and cash equivalents. We consider all highly liquid investments with original maturities of three months or less to be cash equivalents. Included in cash and cash equivalents is an estimate of cash not yet collected at period-end that remains at laundry facilities management locations. At December 31, 2010 and 2009, this totaled $10,360 and $10,524, respectively. We record the estimated cash not yet collected as cash and cash equivalents and facilities management revenue. We also record the estimated related facilities management rent expense. We calculate the estimated cash not yet collected at the end of a period by first identifying only those accounts that have had activity in the last ninety days of the period, since each account is collected at least once every ninety days. We calculate the average collection per day by account for the corresponding period one year prior. The prior year per day collection amount is multiplied by the number of days between the account's most recent collection prior to the end of the current period and the end of the current period. The corresponding period one year prior is used to allow for any seasonality at each account. The average collection per day since inception of the account is used for accounts acquired subsequent to the corresponding period in the prior year.
We have cash deposited with financial institutions in excess of the $250 insured limit of the Federal Deposit Insurance Corporation.
Revenue recognition. We recognize laundry facilities management revenue on the accrual basis. Rental revenue on commercial laundry equipment is recognized ratably over the related contractual period. We recognize revenue from commercial laundry equipment sales upon shipment of the products unless otherwise specified. Shipping and handling fees charged to customers are recognized upon shipment of the products and are included in revenue with related cost included in cost of sales.
We believe our accounting for laundry facilities management revenue and commercial laundry equipment sales are appropriate for us, properly matching the earnings process with the proper reporting period.
Allowance for doubtful accounts. On a regular basis, we review the adequacy of our provision for doubtful accounts for trade accounts receivable based on historical collection results and current economic conditions, using factors based on the aging of our trade accounts receivable. In addition, we
estimate specific additional allowances based on indications that a specific customer may be experiencing financial difficulties.
Inventories. Inventories are stated at the lower of cost (as determined using the average cost method) or market and primarily consist of finished goods. In accordance with Generally Accepted Accounting Principles, we account for our inventory based upon the lower of cost or market principle.
Provision for inventory reserves. On a regular basis, we review the adequacy of our reserve for inventory obsolescence based on historical experience, product knowledge and frequency of shipments.
Goodwill and intangible assets. Intangible assets primarily consist of various non-compete agreements, goodwill and contract rights recorded in connection with acquisitions. 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 or twenty years. The life assigned to acquired contracts is based on several factors, including: (i) the seller's 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 seller's contract portfolio, (iii) the overall level of customer satisfaction within the contract portfolio, and (iv) our ability to maintain or exceed the level of customer satisfaction maintained by the seller prior to the acquisition by us. We are accounting for acquired contract rights on a pool-basis based on the fact that, in general, no single contract accounts for more than 2% of the revenue of any acquired portfolio and the fact that few of the contracts are predicted to be terminated, either prior to or at the end of the contract term. Based on our experience, we believe that these costs associated with various acquisitions are properly recognized and amortized over a reasonable length of time.
We test goodwill at least annually for impairment by reporting unit. The goodwill impairment review consists of a two-step process of first assessing the fair value and comparing to the carrying value. If this fair value exceeds the carrying value, no further analysis or goodwill impairment charge is required. If the fair value is below the carrying value, we would proceed to the next step, which is to measure the amount of the impairment loss. The impairment loss is measured as the difference between the carrying value and implied fair value of goodwill. Any such impairment loss would be recognized in the Company's results of operations in the period the impairment loss arose.
We also evaluate our trade names annually for impairment using the relief from royalty method. We estimate what it would cost to license the trade names based upon estimated future revenue, an estimated royalty rate, a capitalization rate and a discount rate which is subject to change from year to year. If the discounted present value of future tax effected royalty payments is less than the carrying value, the trade name would be written down to its implied fair value. Our evaluation in 2010 did not result in an impairment.
Impairment of Long-Lived Assets. We review long-lived assets, including fixed assets (primarily washing machines and dryers) and intangible assets with definite lives (primarily laundry facilities management contract rights ("contract rights")) for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate.
Assets acquired in business combinations, which include contract rights, an amortizing intangible asset, and equipment are defined to be the asset group for which the portfolio of contracts was acquired. The contract rights were fair valued and recorded in purchase accounting on an aggregate basis for each market and are being amortized over 15 - 20 years. Triggering events that could indicate the carrying value of the contract rights intangible is not fully recoverable may include the loss of significant customers, adverse changes to volumes and/or profitability in specific markets and changes in the Company's business strategy that result in a significant reduction in cash flows generated in a specific market. Management also performs an annual assessment of the useful lives of the contract
rights and accelerates amortization, if necessary. The results of this analysis may also indicate potential impairment triggering events. For contract rights the useful life assessment consists primarily of comparing the percent of revenue declines for acquired contracts in the market where the contract right was acquired to the percent of amortization recorded on the contract rights. A triggering event is deemed to have occurred if the revenues are declining at a rate in excess of the amortization rate. If a triggering event has occurred the recoverability of the carrying amount of the contract rights and fixed assets for that acquired asset group is calculated by comparing the carrying amount of the asset group to the projected future undiscounted cash flows from the operation and disposition of the assets, taking into consideration the remaining useful life of the assets, the length of the contract for that acquisition, as well as any expected renewals. If it is determined that the carrying value of the assets is not recoverable, the Company would write down the long-lived assets by the amount by which the carrying value exceeds fair value.
For the purposes of recognition and measurement of an impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For our long-lived assets acquired in business combinations, the Company has determined the lowest level for which identifiable cash flows are largely independent is at the market level consistent with the approach used in purchase accounting. In particular, the contract rights intangible assets, which comprise thousands of individual contracts, are valued and recorded on an aggregate market basis at the time of acquisition, depreciated in the aggregate, and the recovery of these intangible assets is achieved through the collective cash flows of the market. The Company believes this approach will ensure any significant impairment that occurs is recognized in the appropriate period and that it is not practical to allocate individual contract intangible assets to each of the thousands of locations.
For assets associated with organic contracts, the Company performs its impairment assessment of the long-lived assets (principally laundry equipment) at the individual location level. An impairment test is performed when a triggering event has occurred with respect to individual locations. Triggering events are those events that could indicate the carrying value of the asset group is not fully recoverable and include changes in the current use of the equipment, environmental regulations and technological advancements. If a triggering event has occurred, the recoverability of the carrying amount of the fixed assets for that location is calculated by comparing to the projected future undiscounted cash flows of the assets, taking into consideration the remaining useful life of the assets, the length of the contract for that location, any expected renewals as well as giving consideration to whether or not those assets could be redeployed to another location. If it is determined that the carrying value of the assets is not recoverable, the Company would write down the assets by the amount by which the carrying value exceeds fair value.
Financial instruments. We account for derivative instruments on our balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings, depending on the intended use of the derivative. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. We have designated some of our interest rate swap agreements as cash flow hedges. Accordingly, the change in fair value of the agreements is recognized in other comprehensive income and the ineffective portion of the change is recognized in earnings immediately.
Fair value of financial instruments. For purposes of financial reporting, we have determined that the fair value of financial instruments approximates book value at December 31, 2010 and 2009, based upon terms currently available to us in financial markets. The fair value of the interest rate swaps 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.
Income Taxes. We utilize the asset and liability method of accounting for income taxes, as set forth in accounting guidance. This guidance requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts of the existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
New Accounting Pronouncements
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. The effect of adoption will depend primarily on the Company's acquisitions occurring after such date, if any.
No other new accounting pronouncement issued or effective during the fiscal year has had or is expected to have a material impact on the Consolidated Financial Statements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to a variety of risks, including changes in interest rates on borrowings. In the normal course of business, we manage our exposure to these risks as described below. We do not engage in trading market-risk sensitive instruments for speculative purposes.
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 variable rate debt approximates book value at December 31, 2010.
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 Company has entered into standard International Swaps and Derivatives Association ("ISDA") interest rate swap agreements (the "Swap Agreements") to manage the interest rate risk associated with its debt. The 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 has also entered into an interest rate swap agreement to manage the interest rate associated with its senior unsecured notes. This swap agreement effectively converts a portion ($100 million) of our fixed rate senior unsecured notes to a variable rate. Under this agreement the Company receives the fixed rate on our senior unsecured notes (7.625%) and pays a variable rate of LIBOR plus the applicable margin charged by the banks. The fair value of these interest rate and fuel commodity derivatives are based on quoted prices for similar instruments from a commercial bank and, therefore, the interest rate derivatives are considered a Level 2 item.
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 80,000 gallons from April 1, 2011 through December 31, 2011 for a total notional amount of 720,000 gallons. The Company has a put price of $3.015 per gallon and a strike price of $3.50 per gallon.
Certain of the Company's Swap Agreements qualify as cash flow hedges while others do not. During the fourth quarter of 2010, the Company paid $1,478 to terminate two of its non-hedged Swap Agreements. The change in the fair value of the remaining 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 Swap Agreements that qualify 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 the Company no longer qualified for hedge accounting treatment for one of its swap agreements. Accordingly, $1,260 was reclassified as an earnings charge from Accumulated Other Comprehensive Income in the year ended December 31, 2010.
The remaining balance of $600 associated with this swap and included in Accumulated Other Comprehensive Income will be charged against income through the maturity date of the swap agreement on April 1, 2013.
The table below outlines the details of each remaining Swap Agreement:
In accordance with the 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 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 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 Swap Agreements exposes the Company to credit loss in the event of non-performance; however, nonperformance is not anticipated.
As of December 31, 2010, there was $50,353 outstanding under the 2008 Secured Revolver, $21,750 outstanding under the 2008 Secured Term Loan and $1,380 in outstanding letters of credit. The available balance under the 2008 Secured Revolver was $78,267 at December 31, 2010. The average interest rate on the borrowings outstanding under the 2008 Secured Credit Facility at December 31, 2009 and December 31, 2010 were 6.69% and 5.56%, respectively, including the applicable spread paid to the banks.
Item 8.
Item 8. Financial Statements and Supplementary Data
Financial statements and supplementary data are contained in pages through hereto.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures
(a) 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) and Rule 15(d)-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 December 31, 2010 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. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. On an on-going basis, we review and document our disclosure controls and procedures and our internal control over financial reporting and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business. There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) or Rule 15(d)-15(f) under the Exchange Act) that occurred during the fourth quarter of our fiscal year ended December 31, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
(b) Management's Annual Report on Internal Control over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. The Company's internal control over financial reporting is a process designed under the supervision of the Company's principal executive and
principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of the end of the Company's 2010 fiscal year, management conducted assessments of the effectiveness of the Company's internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on these assessments, management has determined that the Company's internal control over financial reporting as of December 31, 2010 was effective. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on our financial statements.
The Company's internal control over financial reporting as of December 31, 2010 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report appearing on page, which expresses an unqualified opinion on the effectiveness of the firm's internal control over financial reporting as of December 31, 2010.
NYSE Annual CEO Certification. On June 18, 2010, Stewart Gray MacDonald, Jr., Chief Executive Officer of the Company, submitted to the New York Stock Exchange (the "NYSE") the Annual CEO Certification required by Section 303A of the Corporate Governance Rules of the NYSE certifying that he was not aware of any violation by the Company of NYSE corporate governance listing standards.
(c) Changes in Internal Control over Financial Reporting
There were no material changes to management's internal control over financial reporting during the year ended December 31, 2010.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
We will furnish to the SEC a definitive Proxy Statement with respect to our 2011 annual meeting of stockholders (the "Proxy Statement") no later than 120 days after the close of our fiscal year ended December 31, 2010. Certain information required by this Item 10 is incorporated herein by reference to the Proxy Statement.
Item 11.
Item 11. Executive Compensation
The information required by this Item 11 is incorporated herein by reference to the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item 12 is incorporated herein by reference to the Proxy Statement.
Stock Option Plan Information and Employee Stock Purchase Plan Information
The following tables provide information as of December 31, 2010 regarding shares of our common stock that may be issued under our equity compensation plans consisting of the 1997 Stock Option and Incentive Plan (the "1997 Plan"), the 2001 Employee Stock Purchase Plan (the "ESPP"), the 2005 Stock Option and Incentive Plan (the "2005 Plan") and the 2009 Stock Option and Incentive Plan (the "2009 Plan"). There are no equity compensation plans that have not been approved by our stockholders.
(1)Represents outstanding options and restricted shares granted but not yet issued under the 1997 Plan, the 2005 Plan and the 2009 Plan. There are no options, warrants or rights outstanding under the ESPP (does not include the purchase rights accruing under the ESPP because the purchase price, and therefore the number of shares to be purchased, is not determinable until the end of the purchase period).
(2)Includes an aggregate of 149,760 shares underlying restricted stock units granted under the 2005 Plan and the 2009 Plan for which the performance criteria have not yet been established. Accordingly, for accounting purposes, such awards are not considered to be granted under FAS 123R.
(3)Includes 639,241 shares available for future issuance under the 2009 Plan, and 196,387 shares available for future issuance under the ESPP. No new awards may be granted under the 1997 Plan or the 2005 Plan.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item 13 is incorporated herein by reference to the Proxy Statement.
Item 14.
Item 14. Principal Accounting Fees and Services
The information required by this Item 14 is incorporated herein by reference to the Proxy Statement.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a) 1. and 2. An Index to Consolidated Financial Statements and Financial Statement Schedules is on Page of this Report.
3. Exhibits:
Exhibits required by Item 601 of Regulation S-K and Additional Exhibits. Unless otherwise indicated, all exhibits are part of Commission File Number 1-13495. Certain exhibits indicated below are incorporated by reference to documents of Mac-Gray on file with the Commission.
Each exhibit marked by a cross (+) was previously filed as an exhibit to Mac-Gray's Registration Statement on Form S-1 filed on August 14, 1997 (File No. 333-33669) and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form S-1.
Each exhibit marked by a number sign (#) was previously filed as an exhibit to Amendment No. 1 to Mac-Gray's Registration Statement on Form S-1, filed on September 25, 1997 (File No. 333-33669) and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form S-1.
Each exhibit marked by a (z) was previously filed as an exhibit to Amendment No. 1 of Mac-Gray's Registration Statement on Form S-1, filed on April 17, 1998 (File No. 333-49795) and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form S-1.
Each exhibit marked by a (v) was previously filed as an exhibit to Mac-Gray's Form 10-K filed on March 29, 2002 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 10-K.
Each exhibit marked by an (s) was previously filed as an exhibit to Mac-Gray's Form 10-K/A filed on April 11, 2002 and the number in parenthesis following the description of the exhibit refers to the exhibit number in the Form 10-K/A.
Each exhibit marked by an (r) was previously filed as an exhibit to Mac-Gray's Form 10-K filed on March 31, 2005, and the number in parenthesis following the description of the exhibit refers to the exhibit number in the Form 10-K.
Each exhibit marked by a (p) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on May 31, 2005 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (o) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on July 28, 2005 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (n) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on August 18, 2005 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (h) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on March 13, 2007 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (e) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on January 24, 2008 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (c) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on March 7, 2008 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by an (b) was previously filed as an exhibit to Mac-Gray's Form 10-K filed on March 14, 2008, and the number in parenthesis following the description of the exhibit refers to the exhibit number in the Form 10-K.
Each exhibit marked by a (a) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on April 7, 2008 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (yy) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on June 12, 2008 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (xx) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on November 7, 2008 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (vv) was previously filed as an exhibit to Mac-Gray's Form 10-K filed on March 16, 2009 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 10-K.
Each exhibit marked by a (uu) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on May 5, 2009 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (tt) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on May 21, 2009 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (ss) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on June 10, 2009 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (rr) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on June 18, 2009 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (qq) was previously filed as an exhibit to Mac-Gray's Form 10-Q filed on August 10, 2009 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 10-Q.
Each exhibit marked by a (pp) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on January 11, 2010 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (oo) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on February 11, 2010 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (nn) was previously filed as an exhibit to Mac-Gray's Form 10-K filed on March 16, 2010 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 10-K.
Each exhibit marked by a (mm) was previously filed as an exhibit to Mac-Gray's Form 10-Q filed on May 10, 2010 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 10-Q.
Each exhibit marked by a (ll) was previously filed as an exhibit to Mac-Gray's Form 8-K filed on June 2, 2010 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
Each exhibit marked by a (kk) was previously filed as an exhibit to Mac-Gray's Form 8-K/A filed on October 29, 2010 and the number in parentheses following the description of the exhibit refers to the exhibit number in the Form 8-K.
The following is a complete list of exhibits filed or incorporated by reference as part of this Annual Report on Form 10-K.
3.01
Amended and Restated Certificate of Incorporation (3.1)+
3.02
Amendment No. 1 to Amendment and Restated Certificate of Incorporation (filed herewith)
3.03
Amended and Restated By-laws (3.1)xx
3.04
Amendment No. 1 to Amended and Restated By-laws (3.1)kk
3.05
Amended and Restated Certificate of Designations, Preferences and Rights of a Series of Preferred Stock of Mac-Gray Corporation classifying and designating the Series A Junior Participating Cumulative Preferred Stock (3.1)rr
4.01
Specimen certificate for shares of Common Stock, $.01 par value, of the Registrant (4.1)#
4.02
Indenture, dated August 16, 2005, among Mac-Gray Corporation, Mac-Gray Services, Inc., Intirion Corporation and Wachovia Bank, National Association (4.1)n
4.03
Shareholder Rights Agreement, dated as of June 8, 2009, between Mac-Gray Corporation and American Stock Transfer & Trust Company, LLC, as Rights Agent (4.1)ss
10.01
Stockholders' Agreement, dated as of June 26, 1997, by and among the Registrant and certain stockholders of the Registrant (10.2)+
10.02
Form of Maytag Distributorship Agreements (10.13)+
10.03
The Registrant's 1997 Stock Option and Incentive Plan (with form of option agreements attached as exhibits) (10.16)+***
10.04
Form of Noncompetition Agreement between the Registrant and its executive officers (10.15)v***
10.05
Form of Director Indemnification Agreement between the Registrant and each of its Directors (10.16)v***
10.06
April 2001 Amendment to the Mac-Gray Corporation 1997 Stock Option and Incentive Plan (10.17)v***
10.07
Form of executive severance agreement between the Registrant and each of its chief financial officer and chief operating officer (10.18)s***
10.08
Form of executive severance agreement between the Registrant and its chief executive officer (10.19)s***
10.09
Trademark License Agreement dated January 10, 2005 by and between Web Service Company, Inc. ("Licensor") and Mac-Gray Services, Inc. ("Licensee") (10.19)r
10.10
Mac-Gray Corporation 2005 Stock Option and Incentive Plan (10.1)p***
10.11
Form of Incentive Stock Option Agreement under the Mac-Gray Corporation 2005 Stock Option and Incentive Plan (10.2)p***
10.12
Form of Non-Qualified Stock Option Agreement for Company Employees under the Mac-Gray Corporation 2005 Stock Option and Incentive Plan (10.3)p***
10.13
Form of Restricted Stock Award Agreement for awards under the Mac-Gray Corporation 2005 Stock Option and Incentive Plan (10.5)p***
10.14
Lease Agreement, dated July 22, 2005, between Mac-Gray Services, Inc. and 404 Wyman LLC (99.1)o
10.15
Form of Mac-Gray Corporation 75/8% Senior Notes due 2015 (4.2)n
10.16
Form of Employment Agreement between the Company and certain executive officers (10.1)h***
10.17
Mac-Gray Senior Executive Incentive Plan (10.4)e***
10.18
Form of Non-Qualified Stock Option Agreement for Non-Employee Directors under the Mac-Gray Corporation 2005 Stock Option and Incentive Plan (10.5)e***
10.19
Form of executive severance agreement, dated March 3, 2008, between the Registrant and each of Linda Serafini, Robert Tuttle and Phil Emma (10.1)c***
10.20
Form of first amendment to executive severance agreement, dated March 3, 2008, between the Registrant and each of Stewart MacDonald, Michael Shea and Neil MacLellan III (10.42)b***
10.21
Form of first amendment to employment agreement, dated March 3, 2008, between the Registrant and each of Stewart MacDonald, Michael Shea and Neil MacLellan III (10.43)b***
10.22
Senior Secured Credit Agreement, dated as of April 1, 2008, among Mac-Gray Corporation, Mac-Gray Services, Inc., Intirion Corporation, the lenders party thereto, Bank of America, N.A., as Administrative Agent and Collateral Agent, and Banc of America Securities LLC, as Sale Lead Arranger and Sole Book Manager (10.3)a
10.23
Form of Revolving Note pursuant to the Senior Secured Credit Agreement in favor of the Secured Revolving Lenders, in an aggregate total amount of up to $130,000,000 (10.4)a
10.24
Form of Swingline Note pursuant to the Senior Secured Credit Agreement in favor of the Swingline Lenders, in an aggregate total amount of up to $10,000,000 (10.5)a
10.25
Form of Term Loan Note pursuant to the Senior Secured Credit Agreement in favor of the Secured Term Lenders, in an aggregate total amount of $40,000,000 (10.6)a
10.26
Guarantee and Collateral Agreement, dated as of April 1, 2008, among Mac-Gray Corporation, Mac-Gray Services, Inc., Intirion Corporation, the Subsidiaries of the Borrowers identified therein, and Bank of America, N.A., as Administrative Agent (10.7)a
10.27
Mac-Gray Corporation Director Stock Ownership Guidelines, effective as of July 1, 2008 (10.1)yy***
10.28
Form of Indemnification Agreement between the Registrant and each of its non-employee directors (10.1)xx ***
10.29
Form of second amendment to executive severance agreement, dated December 22, 2008, between the Registrant and each of Stewart MacDonald, Michael Shea and Neil MacLellan III (10.59) vv***
10.30
Form of second amendment to employment agreement, dated December 22, 2008, between the Registrant and each of Stewart MacDonald, Michael Shea and Neil MacLellan III (10.60)vv***
10.31
Form of first amendment to executive severance agreement, dated December 22, 2008, between the Registrant and each of Linda Serafini, Robert Tuttle and Phil Emma (10.61)vv***
10.32
Amendment No. 1 to Senior Secured Credit Agreement, dated as of May 1, 2009, among Mac-Gray Corporation, Mac-Gray Services, Inc., Intirion Corporation, the lenders party thereto, and Bank of America, N.A., as Administrative Agent and Collateral Agent (10.1)uu
10.33
Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.1)tt***
10.34
Amendment No. 1 to Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.1)ll***
10.35
Form of Non-Qualified Stock Option Agreement for Company Employees under the Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.5)qq***
10.36
Form of Non-Qualified Stock Option Agreement for Non-Employee Directors under the Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.6)qq***
10.37
Form of Restricted Stock Unit Agreement for cash settled awards under the Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.7)qq***
10.38
Form of Restricted Stock Unit Agreement for stock settled awards under the Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.8)qq***
10.39
Form of Restricted Stock Unit Agreement for awards under the Mac-Gray Corporation 2009 Stock Option and Incentive Plan (10.9)qq***
10.40
Mac-Gray Corporation Non-Employee Director Compensation Policy (10.6)mm***
10.41
Amendment No. 2 to Senior Secured Credit Agreement, dated as of January 8, 2010, among Mac-Gray Corporation, Mac-Gray Services, Inc., Intirion Corporation, the lenders party thereto, and Bank of America, N.A., as Administrative Agent and Collateral Agent (10.1)pp
10.42
Amendment No. 3 to Senior Secured Credit Agreement, dated as of February 5, 2010, among Mac-Gray Corporation, Mac-Gray Services, Inc., Intirion Corporation, the lenders party thereto, and Bank of America, N.A., as Administrative Agent and Collateral Agent (10.1)oo
10.43
Stock Purchase Agreement, dated as of February 5, 2010, between Mac-Gray Corporation and MF Acquisition Corp. (10.2)oo
10.44
Mac-Gray Corporation Long Term Incentive Plan (10.44)nn***
10.45
Mac-Gray Corporation 2001 Employee Stock Purchase Plan (Amended and Restated January 1, 2011) (filed herewith)***
21.1
Subsidiaries of the Registrant (21.1)z
23.1
Consent of PricewaterhouseCoopers LLP (filed herewith)
31.1
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)
31.2
Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002 (filed herewith)
32.1
Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)
***Management compensatory plan or arrangement
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, THIS 14th DAY OF MARCH, 2011.
MAC-GRAY CORPORATION
By:
/s/ STEWART GRAY MACDONALD, JR.
Stewart Gray MacDonald, Jr.
Chief Executive Officer
(Principal Executive Officer)
Date: March 14, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Items 15(a)(1) and (2)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULE
Item 15(a)(1)
The following consolidated financial statements of the registrant and its subsidiaries required to be included in Item 8 are listed below.
Item 15(a)(2)
The following consolidated financial statement schedule of Mac-Gray Corporation should be read in conjunction with the financial statements included herein.
Schedule II Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not material, and therefore have been omitted.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of Mac-Gray Corporation:
In our opinion, the accompanying consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Mac-Gray Corporation (the "Company") and its subsidiaries at December 31, 2010 and December 31, 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index under 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Annual Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 14, 2011
MAC-GRAY CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
MAC-GRAY CORPORATION
CONSOLIDATED INCOME STATEMENTS
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
MAC-GRAY CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
MAC-GRAY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Supplemental disclosure of non-cash investing activities:
During the years ended December 31, 2008, 2009 and 2010, the Company acquired various vehicles under capital lease agreements totaling $1,774, $1,628 and $2,421, respectively.
During the year ended December 31 2008, the Company incurred liabilities in the amount of $10,000 in the form of future cash payments related to acquisition.
The accompanying notes are an integral part of these consolidated financial statements.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data)
1. Description of the Business and Basis of Presentation
Description of the Business. Mac-Gray Corporation ("Mac-Gray" or the "Company") generates the majority of its revenue from card- and coin-operated laundry rooms located in 43 states and the District of Columbia. The Company's principal customer base is the multi-unit housing market, which includes apartments, condominium units, colleges and universities, and military bases. The Company also sells and services commercial laundry equipment to commercial laundromats, multi-unit housing properties and institutions. The majority of the Company's purchases of laundry equipment is from one supplier.
Basis of Presentation. 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 accounted for this business as a discontinued operation. All current and prior period financial information has been classified to reflect this as a discontinued operation.
2. Significant Accounting Policies
Cash and Cash Equivalents. The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Included in cash and cash equivalents is an estimate of cash not yet collected at period-end that remains at laundry facilities management customer locations. At December 31, 2009 and 2010, this totaled $10,524 and $10,360, respectively. The Company monitors current collection levels and economic conditions and adjusts the estimate as circumstances warrant. The Company records the estimated cash not yet collected as cash and cash equivalents and facilities management revenue. The Company also records the estimated related facilities management rent expense. The Company calculates the estimated cash not yet collected at the end of a period by first identifying only those accounts that have had activity in the last ninety days of the period, since each account is collected at least once every ninety days. The Company calculates the average collection per day by account for the corresponding period one year prior. The prior year per day collection amount is multiplied by the number of days between the account's most recent collection prior to the end of the current period and the end of the current period. The corresponding period one year prior is used to allow for any seasonality at each account. The average collection per day since inception of the account is used for accounts acquired subsequent to the corresponding period in the prior year.
The Company has cash deposited with financial institutions in excess of the $250 insured limit of the Federal Deposit Insurance Corporation.
Revenue Recognition. The Company recognizes facilities management revenue on the accrual basis. Rental revenue is recognized ratably over the related contractual period. The Company recognizes revenue from sales upon shipment of the products, unless otherwise specified. Shipping and handling fees charged to customers are recognized upon shipment of the products and are included in revenue with the related cost included in cost of sales. Installation and repair services are provided on
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
2. Significant Accounting Policies (Continued)
an occurrence basis, not on a contractual basis. Related revenue is recognized at the time the installation service, or other service, is provided to the customer.
Allowance for Doubtful Accounts. On a regular basis, the Company reviews the adequacy of its provision for doubtful accounts for trade accounts receivable based on historical collection results and current economic conditions using factors based on the aging of its trade accounts. In addition, the Company estimates specific additional allowances based on indications that a specific customer may be experiencing financial difficulties. The Company maintains an allowance for doubtful trade accounts of $198 and $329 at December 31, 2009 and 2010, respectively.
Concentration of Credit Risk. Financial instruments which potentially expose the Company to concentration of credit risk include trade receivables generated by the Company as a result of the selling and leasing of laundry equipment. To minimize this risk, ongoing credit evaluations of customers' financial condition are performed and reserves are maintained. The Company typically does not require collateral. No individual Laundry Equipment Sales customer accounted for more than 10% of revenues or accounts receivable for any period presented.
Inventories. Inventories are stated at the lower of cost (as determined using the average cost method) or market, and consist primarily of finished goods.
Provision for Inventory Reserves. On a regular basis, the Company reviews the adequacy of its reserve for inventory obsolescence based on historical experience, product knowledge and frequency of shipments. The Company maintains an inventory reserve of $230 and $252 at December 31, 2009 and 2010, respectively.
Prepaid Facilities Management Rent. Prepaid facilities management rent consists of cash advances paid to property owners and managers under laundry service contracts.
Property, Plant and Equipment. Property, Plant and Equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the respective assets. Expenditures for maintenance and repairs are charged to operations as incurred; acquisitions, major renewals, and betterments are capitalized. Upon retirement or sale, the cost of assets disposed of and their related accumulated depreciation or amortization are removed from the accounts, with the resulting gain or loss reflected in income.
Facilities Management Equipment-Not Yet Placed in Service. These assets represent laundry machines that management estimates will be installed in facilities management laundry rooms over the next twelve months and have not been purchased for commercial sale. These assets are grouped in Property, Plant and Equipment and are not depreciated until placed in service under a facilities management lease agreement.
Advertising Costs. Advertising costs are expensed as incurred. These costs were $696, $553, and $1,153 for the years ended December 31, 2008, 2009 and 2010, respectively.
Goodwill and Intangible Assets. Intangible assets primarily consist of various non-compete agreements, goodwill, trade name and contract rights recorded in connection with acquisitions. The non-compete agreements are amortized using the straight-line method over the life of the agreements,
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
2. Significant Accounting Policies (Continued)
which range from five to fifteen years. The majority of contract rights are amortized using the straight-line method over twenty years, with the balance amortized on a straight-line method over fifteen years. The life assigned to acquired contracts is based on several factors, including: the seller's renewal rate of the contract portfolio for the most recent years prior to the acquisition, the number of years the average contract has been in the seller's contract portfolio, the overall level of customer satisfaction within the contract portfolio and the ability of the Company to maintain or exceed the level of customer satisfaction maintained by the seller prior to the acquisition by the Company. The Company is accounting for acquired contract rights on a pool-basis based on the fact that, in general, no single contract accounts for more than 2% of the revenue of any acquired portfolio and the fact that few of the contracts are predicted to be terminated, either prior to or at the end of the contract term.
We test goodwill at least annually for impairment by reporting unit. The goodwill impairment review consists of a two-step process of first assessing the fair value of the reporting unit and comparing this to the carrying value. If this fair value exceeds the carrying value of the reporting unit, no further analysis or goodwill impairment charge is required. If the fair value is below the carrying value, we would proceed to the next step, which is to measure the amount of the impairment loss. The impairment loss is measured as the difference between the carrying value and implied fair value of goodwill. Any such impairment loss would be recognized in the Company's results of operations in the period the impairment loss arose.
We also evaluate our trade names annually for impairment using the relief from royalty method. We estimate what it would cost to license the trade names based upon estimated future revenue, an estimated royalty rate, capitalization rate and a discount rate which is subject to change from year to year. If the discounted present value of future tax effected royalty payments is less than the carrying value of the trade names, the trade name would be written down to its implied fair value. Our evaluation in 2010 did not result in an impairment.
Impairment of Long-Lived Assets. The Company reviews long-lived assets, including fixed assets (primarily washing machines and dryers) and intangible assets with definite lives (primarily laundry facilities management contract rights ("contract rights")) for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate.
Assets acquired in business combinations, which include contract rights, an amortizing intangible asset, and equipment are defined to be the asset group for which the portfolio of contracts was acquired. The contract rights were fair valued and recorded in purchase accounting on an aggregate basis for each market and are being amortized over 15 - 20 years. Triggering events that could indicate the carrying value of the contract rights intangible is not fully recoverable may include the loss of significant customers, adverse changes to volumes and/or profitability in specific markets and changes in the Company's business strategy that result in a significant reduction in cash flows generated in a specific market. Management also performs an annual assessment of the useful lives of the contract rights and accelerates amortization, if necessary. The results of this analysis may also indicate potential impairment triggering events. For contract rights the useful life assessment consists primarily of comparing the percent of revenue declines for acquired contracts in the market where the contract right was acquired to the percent of amortization recorded on the contract rights. A triggering event is
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
2. Significant Accounting Policies (Continued)
deemed to have occurred if the revenues are declining at a rate in excess of the amortization rate. If a triggering event has occurred the recoverability of the carrying amount of the contract rights and fixed assets for that acquired asset group is calculated by comparing the carrying amount of the asset group to the projected future undiscounted cash flows from the operation and disposition of the assets, taking into consideration the remaining useful life of the assets, the length of the contract for that acquisition, as well as any expected renewals. If it is determined that the carrying value of the assets is not recoverable, the Company would write down the long-lived assets by the amount by which the carrying value exceeds fair value.
For the purposes of recognition and measurement of an impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For our long-lived assets acquired in business combinations, the Company has determined the lowest level for which identifiable cash flows are largely independent is at the market level consistent with the approach used in purchase accounting. In particular, the contract rights intangible assets, which comprise thousands of individual contracts, are valued and recorded on an aggregate market basis at the time of acquisition, depreciated in the aggregate, and the recovery of these intangible assets is achieved through the collective cash flows of the market. The Company believes this approach will ensure any significant impairment that occurs is recognized in the appropriate period and that it is not practical to allocate individual contract intangible assets to each of the thousands of locations.
For assets associated with organic contracts, the Company performs its impairment assessment of the long-lived assets (principally laundry equipment) at the individual location level. An impairment test is performed when a triggering event has occurred with respect to individual locations. Triggering events are those events that could indicate the carrying value of the asset group is not fully recoverable and include changes in the current use of the equipment, environmental regulations and technological advancements. If a triggering event has occurred, the recoverability of the carrying amount of the fixed assets for that location is calculated by comparing to the projected future undiscounted cash flows of the assets, taking into consideration the remaining useful life of the assets, the length of the contract for that location, any expected renewals as well as giving consideration to whether or not those assets could be redeployed to another location. If it is determined that the carrying value of the assets is not recoverable, the Company would write down the assets by the amount by which the carrying value exceeds fair value.
Income Taxes. The Company utilizes the asset and liability method of accounting for income taxes, as set forth in accounting guidance. This guidance requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts of the existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.
Stock Compensation. Accounting guidance requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized on a straight-line basis over the period during which an
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
2. Significant Accounting Policies (Continued)
employee is required to provide service in exchange for the award-the requisite service period (usually the vesting period).
The grant-date fair value of employee share options and similar instruments is estimated using the Black-Scholes option-pricing model. The expected life of options and the expected forfeiture rates are estimated based on historical experience. The weighted average volatility of the Company's stock price over the prior number of years equal to the expected life and the two most recent years is used to estimate the expected volatility at the measurement date. Awards for which the recipient has the choice of receiving equity instruments or cash are valued at the market price of the underlying equity instrument as of the reporting date.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Earnings Per Share. Accounting guidance requires the presentation of basic earnings per share ("EPS") and diluted earnings per share. Basic EPS includes no dilution and is computed by dividing net income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution of securities that could share in the earnings of an entity. Diluted EPS has been calculated using the treasury stock method.
Comprehensive Income. Comprehensive income includes all changes in stockholders' equity during a period except those resulting from investments by stockholders and distributions to stockholders.
Financial Instruments. The Company accounts for derivative instruments on its balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through earnings. If the derivative is a hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings, depending on the intended use of the derivative. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings.
The Company has adopted accounting guidance, 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.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
2. Significant Accounting Policies (Continued)
The fair value of the Company's interest rate and fuel commodity derivatives are based on quoted prices for similar instruments from a commercial bank and, therefore, the interest rate derivatives are considered a Level 2 item.
Fair Value of Financial Instruments. For purposes of financial reporting, the Company has determined that the fair value of financial instruments approximates book value at December 31, 2009 and 2010, based upon terms currently available to the Company in financial markets. The fair value of the Company's interest rate swaps is the estimated amount that the Company 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.
New Accounting Pronouncements. 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. The effect of adoption will depend primarily on the Company's acquisitions occurring after such date, if any.
No other new accounting pronouncement issued or effective during the fiscal year has had or is expected to have a material impact on the Consolidated Financial Statements.
3. Revisions to Balance Sheet Presentation
During the December 31, 2010 year end closing process, the Company determined that the December 31, 2009 fair value of derivative instruments was not properly classified on the balance sheet between current and long term liabilities. The Company previously classified their derivative instruments as current versus long term liabilities based on the maturity date of their derivative contracts. The Company currently bases their classification on the estimated timing of the cash flows associated with their derivative contracts. This change in classification does not impact the consolidated statement of operations or the consolidated statement of cash flows for any period. Accordingly, to correct the error in the classification of derivative instruments, the Company has revised its balance sheet as of December 31, 2009 by increasing other current liabilities and decreasing other long term liabilities by $3,382 (See Note 6 "Fair Value Measurements".)
4. Discontinued Operations
On February 5, 2010, the Company sold its MicroFridge® (Intirion Corporation) business to Danby Products. The transaction is valued at approximately $11,500. Danby Products paid Mac-Gray $8,500 in cash, and assumed existing liabilities and financial obligations for MicroFridge totaling approximately $3,000. The operations and cash flows of this business have been eliminated from the ongoing
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
4. Discontinued Operations (Continued)
operations of the company as the 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 current and 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 Secured Term Loan.
Included in the table below are the key financial items related to the discontinued operation:
(1)Represents the amount of interest 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 5.3%, 3.3%, and 2.5% for the years ended December 31, 2008, 2009 and 2010, respectively.
5. Long-Term Debt
The Company has a senior secured credit agreement (the "Secured Credit Agreement") pursuant to which the Company may borrow up to $151,750 in the aggregate, including $21,750 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 there under, 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 the Company's senior secured leverage ratio.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
5. Long-Term Debt (Continued)
The obligations under the Secured Credit Agreement are guaranteed by the Company's subsidiaries and secured 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 December 31, 2010.
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 December 31, 2010, there was $50,353 outstanding under the Revolver, $21,750 outstanding under the Term Loan and $1,380 in outstanding letters of credit. The available balance under the Revolver was $78,267 at December 31, 2010. The average interest rates on the borrowings outstanding under the Secured Credit Agreement at December 31, 2009 and 2010 were 6.69% and 5.56%, respectively, including the applicable spread paid to the banks.
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. The maturity date of the notes is August 15, 2015. The proceeds from the senior notes, less financing costs, were used to pay
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
5. Long-Term Debt (Continued)
down senior bank debt. Since the senior notes are not widely traded, the market value of these notes approximates book value at December 31, 2010.
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:
As of December 31, 2010, the Company had not redeemed any of its senior notes.
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 December 31, 2010.
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 December 31, 2010.
Capital lease obligations on the Company's fleet of vehicles totaled $3,276 and $3,833 at December 31, 2009 and 2010, respectively.
Required payments under the Company's long-term debt and capital lease obligations are as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
5. Long-Term Debt (Continued)
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.
6. 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:
The Company has entered into standard International Swaps and Derivatives Association ("ISDA") interest rate swap agreements (the "Swap Agreements") to manage the interest rate risk associated with its debt. The 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 has also entered into an interest rate swap agreement to manage the interest rate associated with its senior unsecured notes. This swap agreement effectively converts a portion
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
6. Fair Value Measurements (Continued)
($100 million) of our fixed rate senior unsecured notes to a variable rate. Under this agreement the Company receives the fixed rate on our senior unsecured notes (7.625%) and pays a variable rate of LIBOR plus the applicable margin charged by the banks. This swap agreement has an associated call feature that allows the counterparty to terminate this agreement at their option. The fair value of these interest rate and fuel commodity derivatives are based on quoted prices for similar instruments from a commercial bank and, therefore, are considered a Level 2 item.
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 80,000 gallons from April 1, 2011 through December 31, 2011 for a total notional amount of 720,000 gallons. The Company has a put price of $3.015 per gallon and a strike price of $3.50 per gallon.
Certain of the Company's Swap Agreements qualify as cash flow hedges while others do not. During the fourth quarter of 2010, the Company paid $1,478 to terminate two of its non-hedged Swap Agreements. The change in the fair value of the remaining 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 Swap Agreements that qualify 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 the Company no longer qualified for hedge accounting treatment for one of its swap agreements. Accordingly, $1,260 was reclassified as an earnings charge from Accumulated Other Comprehensive Loss in the year ended December 31, 2010. The remaining balance of $600 associated with this swap and included in Accumulated Other Comprehensive Loss will be charged against income through the maturity date of the swap agreement on April 1, 2013.
The table below outlines the details of each remaining Swap Agreement:
In accordance with the 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 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 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.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
6. Fair Value Measurements (Continued)
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 Swap Agreements exposes 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 Consolidated Balance Sheets as of December 31, 2009 and 2010 and the Consolidated Income Statements for the years ended December 31, 2009 and 2010.
Fair Values of Derivative Instruments
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
6. Fair Value Measurements (Continued)
The Effect of Derivative Instruments on the Consolidated Income Statements
For the Years Ended December 31, 2008, 2009 and 2010
The net of the amount reclassified from Other Comprehensive Income and the unrealized gain recognized on the derivatives resulted in a loss of $1,804 for the year ended December 31, 2008 and gains of $893 and $1,454 for the years December 31, 2009 and 2010, respectively.
7. Prepaid Facilities Management Rent and Other Current Assets
Prepaid facilities management rent and other current assets consist of the following:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
8. Prepaid Facilities Management Rent and Other Assets
Prepaid facilities management rent and other assets consist of the following:
9. Property, Plant and Equipment
Property, plant and equipment consist of the following:
Depreciation of property, plant and equipment totaled $33,373, $33,461, and $31,129 for the years ended December 31, 2008, 2009 and 2010, respectively.
At December 31, 2009 and 2010, trucks and autos included $9,537 and $10,736, respectively, of equipment under capital lease with an accumulated amortization balance of $6,261 and $6,903, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
10. Goodwill and Intangible Assets
Goodwill and intangible assets consist of the following:
Estimated future amortization expense of intangible assets consists of the following:
Amortization expense of intangible assets for the years ended December 31, 2008, 2009 and 2010 was $12,213, $13,139, and $13,234, respectively.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
11. Accrued Expenses
Accrued expenses consist of the following:
12. Income Taxes
The provision for state and federal income taxes consists of the following:
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
12. Income Taxes (Continued)
The net deferred tax liability in the accompanying balance sheets includes the following amounts of deferred tax assets and liabilities at December 31:
For the years ended December 31, 2008, 2009 and 2010, the statutory income tax rate differed from the effective rate primarily as a result of the following differences:
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
12. Income Taxes (Continued)
At December 31, 2010, the Company had a federal net operating loss carryforward of $3,429, of which $520 expires in the year 2028 and $2,909 expires in the year 2029, and state net operating loss carryforwards of $1,340 which expire at various times through the year 2030. The Company has evaluated the positive and negative evidence bearing upon the realization of the Net Operating Losses and has increased the valuation allowance to $451 for the corresponding deferred tax asset, which is comprised principally of state net operating loss carryovers incurred not expected to be utilized.
The Company and its subsidiaries are subject to U.S. federal income tax as well as to income tax of multiple state jurisdictions. The Company has concluded all U.S. federal income tax matters for years through 2006. All material state and local income tax matters have been concluded for years through 2005.
13. Acquisitions
On April 1, 2008, the Company acquired Automatic Laundry Company, Ltd., ("ALC"), a laundry facilities management business, which operates in several western and southern states. This acquisition has been reflected in the accompanying consolidated financial statements from the date of the acquisition, and has been accounted for as a purchase business combination in accordance with accounting guidance. The total purchase price of this acquisition has been allocated to the acquired assets and liabilities, based on estimates of their relative fair value. A twenty-year amortization period has been assigned to the acquired contract rights and the acquired used laundry equipment has been assigned an average life of four years based upon physical inspection of the equipment. The Company's operations were fully integrated at December 31, 2008. The acquisition of this business addresses the Company's growth objectives by creating density within several markets the Company already serves.
The total purchase price for this acquisition was allocated as follows:
Goodwill includes $6,529 of tax goodwill due to the difference between the book value and the tax value assigned to the acquired equipment. The depreciation of the book and tax values over time will create a deferred tax asset equal to the deferred tax liability recorded as part of the acquisition.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
13. Acquisitions (Continued)
The purchase price includes a non-recourse note payable to the seller in the amount of $10,000 due on April 1, 2010. The Company paid this note in full on June 16, 2009. As part of this acquisition, the Company also leased from a third party a fleet of vehicles previously owned by ALC.
The following unaudited pro forma operating results of the Company assume the acquisition took place on January 1, 2008. Such information includes adjustments to reflect additional depreciation, amortization and interest expense, and is not necessarily indicative of what the results of operations would have been or the results of operations in future periods.
14. Preferred Stock Purchase Rights
The Company has adopted a Shareholder Rights Agreement, the purpose of which is, among other things, to enhance the Board's ability to protect shareholder interests and to ensure that shareholders receive fair treatment in the event any coercive takeover attempt of the Company is made in the future. The Shareholder Rights Agreement could make it more difficult for a third party to acquire, or could discourage a third party from acquiring, the Company or a large block of the Company's Common Stock. The following summary description of the Shareholder Rights Agreement does not purport to be complete and is qualified in its entirety by reference to the Company's Shareholder Rights Agreement, which has been previously filed with the Securities and Exchange Commission as an exhibit to a Registration Statement on Form 8-A.
Pursuant to the terms of a Shareholder Rights Agreement (the "Rights Agreement"), the Board of Directors declared a dividend distribution on June 15, 2009 of one Preferred Stock Purchase Right (a "Right") for each outstanding share of Common Stock of the Company (the "Common Stock") to stockholders of record as of the close of business on June 15, 2009 (the "Record Date"). In addition, one Right will automatically attach to each share of Common Stock issued between the Record Date and the Distribution Date (as hereinafter defined). Under certain circumstances, each Right entitles the holder thereof to purchase from the Company a unit consisting of one ten thousandth of a share (a "Unit") of Series A Junior Participating Cumulative Preferred Stock, par value $.01 per share, of the Company (the "Preferred Stock"), at a cash exercise price of $45.00 per Unit, subject to adjustment. The Rights are not exercisable and are attached to and trade with all shares of Common Stock outstanding as of, and issued subsequent to, the Record Date until the earlier to occur of (i) the close of business on the tenth calendar day following the first public announcement that a person or group of affiliated or associated persons (an "Acquiring Person") has acquired beneficial ownership of 15% or more of the outstanding shares of Common Stock, other than as a result of repurchases of stock by the Company or certain inadvertent actions by a stockholder (the date of said announcement being referred to as the "Stock Acquisition Date") or (ii) the close of business on the tenth business day (or
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
14. Preferred Stock Purchase Rights (Continued)
such later day as the Board of Directors may determine) following the commencement of a tender offer or exchange offer that could result upon its consummation in a person or group becoming the beneficial owner of 15% or more of the outstanding shares of Common Stock (the earlier of such dates being herein referred to as the "Distribution Date"). The Rights will expire at the close of business on June 15, 2019 (the "Expiration Date"), unless previously redeemed or exchanged by the Company as described below. Until a Right is exercised, the holder will have no rights as a stockholder of the Company (beyond those as an existing stockholder), including the right to vote or to receive dividends.
In the event that a Stock Acquisition Date occurs, each holder of a Right (other than an Acquiring Person) will be entitled to receive upon exercise, in lieu of a number of Units of Preferred Stock, that number of shares of Common Stock having a market value of two times the exercise price of the Right. In the event that, at any time following the Stock Acquisition Date, (i) the Company merges with and into any other person, and the Company is not the continuing or surviving corporation, (ii) any person merges with and into the Company and the Company is the continuing or surviving corporation of such merger and, in connection with such merger, all or part of the shares of Common Stock are changed into or exchanged for securities of any other person or cash or any other property, or (iii) 50% or more of the Company's assets or earning power is sold, each holder of a Right (other than an Acquiring Person) will be entitled to receive, upon exercise, common stock of the acquiring company having a market value equal to two times the exercise price of the Right. Rights that are or were beneficially owned by an Acquiring Person may (under certain circumstances specified in the Rights Agreement) become null and void.
The Rights may be redeemed in whole, but not in part, at a price of $0.001 per Right by the Board of Directors only until the earlier of (i) the time at which any person becomes an Acquiring Person or (ii) the Expiration Date.
15. 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, results of its operations, or its cash flow.
Leases. The Company leases certain equipment and facilities under non-cancelable operating leases. The Company also leases certain vehicles under capital leases.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
15. Commitments and Contingencies (Continued)
Future minimum lease payments under non-cancelable operating and capital leases consist of the following:
Rent expense incurred by the Company under non-cancelable operating leases totaled $3,942, $3,966, and $4,338 for the years ended December 31, 2008, 2009 and 2010, respectively.
Guaranteed Facilities Management Rent Payments. The Company operates card- and coin-operated facilities management laundry rooms under various lease agreements in which the Company is required to make minimum guaranteed rent payments to the respective lessors. The following is a schedule by years of future minimum guaranteed rent payments required under these lease agreements that have initial or remaining non-cancelable contract terms in excess of one year as of December 31, 2010:
16. Employee Benefit and Stock Plans
Retirement Plans. The Company maintains a qualified profit-sharing/401(k) plan (the "Plan") covering substantially all employees. The Company's contributions to the Plan are at the discretion of the Board of Directors. Costs under the Plan amounted to, $1,410, $1,396 and $0 for the years ended December 31, 2008, 2009 and 2010, respectively.
Stock Option and Incentive Plans. On April 7, 1997, the Company's stockholders approved the 1997 Stock Option and Incentive Plan for the Company (the "1997 Stock Plan"). On May 26, 2005, the Company's stockholders approved the 2005 Stock Option and Incentive Plan for the Company (the
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
16. Employee Benefit and Stock Plans (Continued)
"2005 Stock Plan"). On May 8, 2009, the Company's stockholders approved the 2009 Stock Option and Incentive Plan for the Company which was amended by the stockholders on May 26, 2010 (the "2009 Stock Plan" and together with the 1997 and 2005 Stock Plans the "Stock Plans"). The Stock Plans are designed and intended as a performance incentive for officers, employees, and independent directors to promote the financial success and progress of the Company. All officers, employees and independent directors are eligible to participate in the Stock Plans. Awards, when made, may be in the form of stock options, restricted stock, restricted stock units, unrestricted stock options, and dividend equivalent rights. The Stock Plans require the maximum term of options to be ten years. Costs under the Plans amounted to, $2,271, $2,593, and $3,195 for the years ended December 31, 2008, 2009 and 2010, respectively. The related income tax benefit recognized was $853, $1,350, and $1,366 for the years ended December 31, 2008, 2009 and 2010, respectively.
Employee options generally vest such that one-third of the options will become exercisable on each of the first through third anniversaries of the date of grant of the options; however, the administrator of the Stock Plans may determine, at its discretion, the vesting schedule for any option award. In the event of termination of the optionee's relationship with the Company, vested options not yet exercised terminate within 90 days. The non-qualified options granted to independent directors as part of their annual compensation are exercisable on May 1st of the succeeding year and terminate ten years from the date of the grant. Directors have one year after leaving the board to exercise their options. The exercise prices are the fair market value of the shares underlying the options on the respective dates of the grants. The Company issues shares upon exercise of options from its treasury shares, if available. The grant-date fair value of employee share options and similar instruments is estimated using the Black-Scholes option-pricing model.
The fair values of the stock options granted in 2008, 2009, and 2010 were estimated using the following components:
The expected volatility of the Company's stock price was based on the weighted average of the historical performance over the prior number of years equal to the expected term and the two most recent years.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
16. Employee Benefit and Stock Plans (Continued)
The following is a summary of stock option plan activity under the Plans as of December 31, 2010, and changes during the year then ended:
A summary of the status of the Company's nonvested shares as of December 31, 2010 and changes during the year then ended is presented below:
In the year ended December 31, 2010, the Company granted restricted stock units covering 89,835 shares of stock with an average fair market value on date of grant of $9.31 per share. The stock vests in one year upon the achievement of certain performance objectives as determined by the Board of Directors at the beginning of the fiscal year. In addition, the Company granted a cash award equivalent to 46,375 restricted stock units and subject to the same performance criteria. The award had a fair market value of $14.95 per share at December 31, 2010. As part of their annual compensation, the Company granted the independent directors 42,096 restricted stock units with a fair market value
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
16. Employee Benefit and Stock Plans (Continued)
on the date of grant of $11.40. The restricted stock units vest over three years. The Company also granted restricted stock units covering 5,812 shares of stock with a fair market value of $10.32 per share that vest over three years which do not have a performance requirement. Restricted stock activity for fiscal 2010 is presented below:
Compensation expense related to nonvested options and restricted shares will be recognized in the following years:
At December 31, 2010, the stock plans provide for the issuance of up to 4,524,731 shares of Common Stock of which 1,385,843 shares have been issued pursuant to the exercise of option agreements or restricted stock awards. At December 31, 2010 1,996,577 shares are subject to outstanding options, 203,550 shares have been granted, of which 136,210 are subject to certain performance criteria and 938,761 shares remain available for issuance. Of the 938,761 shares, 299,520 shares have been committed to future restricted stock awards for which performance criteria have not yet been established. Upon the adoption of the 2009 plan, no additional options can be issued from the 1997 and 2005 plans.
Mac-Gray Corporation 2001 Employee Stock Purchase Plan. The Company established the Mac-Gray Corporation 2001 Employee Stock Purchase Plan (the "ESPP") in May 2001. Under the terms of the ESPP, eligible employees may have between 1% and 15% of eligible compensation deducted from their pay to purchase Company Common Stock. The per share purchase price is the fair market value of the stock on, the lower of, the first day or the last day of each six month interval. Up to 500,000 shares may be offered pursuant to the ESPP. The plan includes certain restrictions, such as
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
16. Employee Benefit and Stock Plans (Continued)
the holding period of the stock by employees. At December 31, 2010 there were 77 participants in the ESPP. The number of shares of Common Stock purchased through the ESPP was 67,372 and 25,821 for the years ended December 31, 2009 and 2010, respectively. There have been 303,613 shares purchased since the inception of the ESPP. At December 31, 2009 and 2010, the Company had accumulated employee withholdings associated with this plan of $120 and $103 for acquisition of stock in 2010 and 2011, respectively.
17. Payment of dividends
On February 5, 2010, the Company's Board of Directors approved the initiation of a quarterly dividend policy for its common stock. The Company had not previously paid dividends on any of its shares of capital stock. The Company declared dividends of $0.05 per share payable on April 1, 2010, July 1, 2010, October 1, 2010 and January 3, 2011. All dividends were paid and have been reflected in the current financial statements.
18. Earnings Per Share
There were 1,189 shares at December 31, 2008, 850 shares at December 31, 2009 and 671 shares at December 31. 2010 under option plans that were excluded from the computation of diluted earnings per share at December 31, 2008, 2009 and 2010, respectively, due to their anti-dilutive effects.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
19. Summary of Quarterly Financial Information (unaudited)
(a)The sum of the quarterly earnings per share amounts may not equal the full year amount since the computations of the weighted average shares outstanding for each quarter and the full year are computed independently of each other.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
19. Summary of Quarterly Financial Information (unaudited) (Continued)
(a)The sum of the quarterly earnings per share amounts may not equal the full year amount since the computations of the weighted average shares outstanding for each quarter and the full year are computed independently of each other.
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(In thousands, except per share data)
20. Subsequent Events
On January 20, 2011, the Company's Board of Directors approved an increase to the quarterly dividend policy to $0.055 per share ($0.22 per share on an annualized basis). The Board declared a dividend of $0.055 per share payable on April 1, 2011, to stockholders of record at the close of business on March 15, 2011.
MAC-GRAY CORPORATION
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2007, 2008, AND 2009