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TUC > SEC Filings for TUC > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for MAC-GRAY CORP


8-Nov-2013

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

† our ability to satisfy the closing conditions set forth in our recently announced merger agreement with CSC ServiceWorks, including obtaining stockholder approval and antitrust clearance;

†††††††††††††††††††††††††††††††††††† the ability of the parties to consummate our recently announced transaction with CSC ServiceWorks;

† debt service requirements under our existing and future indebtedness;

† availability of cash flow to finance capital expenditures;

† our ability to renew laundry leases with our clients;

† competition in the laundry facilities management industry;

†                   our ability to maintain relationships with our suppliers;



†                   our ability to maintain adequate internal controls over
financial reporting;

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

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

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

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

†                   decreases in the value of our intangible assets;



†                   our ability to comply with current and future environmental
regulations;



†                   actions of our controlling stockholders;



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

† those factors discussed under Item 1A "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 and our other filings with the Securities and Exchange Commission ("SEC").

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


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In this Quarterly Report on Form 10-Q, unless the context suggests otherwise, references to the "Company," "Mac-Gray," "we," "us," "our" and similar terms refer to Mac-Gray Corporation and its subsidiaries. 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® .

Overview

Mac-Gray Corporation was founded in 1927 and re-incorporated in Delaware in 1997. Since its founding, Mac-Gray has grown to become the second largest laundry facilities management 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 universities, public housing complexes, and hotels and motels in 44 states and the District of Columbia. Based on our ongoing survey of colleges and universities, we believe we are the largest provider of such services to the college and university market in the United States.

Our business model is built on a stable demand for laundry services, combined with long-term leases, strong client relationships, a broad client base, and predictable capital needs. For the three and nine months ended September 30, 2013, our total revenue was $79,511 and $240,325, respectively. Approximately 95% of our total revenue for the three and nine month period was generated by our facilities management business. We generate facilities management revenue primarily by entering into long-term leases with property owners or property management companies for the exclusive right to install and maintain laundry equipment in common area laundry rooms within their properties in exchange for a negotiated portion of the revenue we collect. As of September 30, 2013, approximately 83% of our installed equipment base was located in laundry facilities subject to long-term leases, which have a weighted average remaining term of approximately five years. Our capital costs are typically incurred in connection with new or renewed leases, and include investments in laundry equipment and card and coin-operated systems, incentive payments to property owners or property management companies, and expenses to refurbish laundry facilities. Our capital costs consist primarily of a large number of relatively small amounts, which are associated with our entry into or renewal of leases. Our capital needs other than for laundry leases are not significant. Accordingly, our capital needs are predictable and largely within our control. For the three and nine months ended September 30, 2013, we incurred $10,960 and $30,799 of capital expenditures, respectively. In addition, we made incentive payments of $2,196 and $5,281 in the three and nine months ended September 30, 2013 to property owners and property management companies in connection with obtaining our lease arrangements.

Through our commercial equipment sales and services business, we generate revenue by selling commercial laundry equipment. For the three and nine months ended September 30, 2013, our commercial laundry equipment sales business generated approximately 6% and 5% of our total revenue, respectively, and 8% and 5% of our gross margin, respectively. We anticipate that tight credit markets for our clients will continue to challenge our ability to maintain and grow our revenue from laundry equipment sales.

One of the key challenges we face is maintaining and expanding our client base in a competitive industry. Approximately 8% to 10% of our laundry room leases are up for renewal each year. Within any given geographic area, Mac-Gray may compete with local independent operators, regional operators and multi-region operators as well as property owners and property management companies who self-operate their laundry facilities. We devote substantial resources to our sales efforts and are focused on continued innovation in order to distinguish us from our competitors.

Our Board of Directors declared quarterly dividends of $0.0875 per share payable on April 1, 2013, July 1, 2013, and October 1, 2013 to stockholders of record at the close of business on March 15, 2013, June 17, 2013, and September 16, 2013, respectively. All dividends were paid prior to September 30, 2013 and have been reflected in the current financial statements.

On April 5, 2013 the Company's Board of Directors voted to terminate the Company's shareholder rights plan with American Stock Transfer & Trust Company, LLC ("AST"), as of the close of business April 8, 2013. In order to effect the termination, the Company and AST entered into an Amendment and Termination of Shareholder Rights Agreement, dated as of April 8, 2013, which caused the rights to purchase Series A Junior Participating Cumulative Preferred Stock issued pursuant to the Shareholder Rights Agreement, dated as of September 8, 2009, by and between the Company and AST, to expire as of April 8, 2013.

On February 29, 2012, we entered into an Amended and Restated Senior Secured Credit Agreement (as amended,


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the "2012 Credit Agreement"). On May 17, 2013, we entered into Amendment No. 1 to the Amended and Restated Senior Secured Credit Agreement. The 2012 Credit Agreement provides for borrowings up to $250,000 under a revolving credit facility (the "Revolver").

On March 1, 2013, we acquired a laundry facilities management business in the southeastern region of the United States for total consideration of $2,737.

On May 2, 2013, we acquired a laundry facilities management business in the southwestern region of the United States for total consideration of $1,326.

On June 28, 2013 we acquired a laundry facility in the northeastern region of the United States for total consideration of $619.

On September 27, 2013 we acquired a laundry facilities management business in the northeastern region of the United States for total consideration of $1,165.

On October 14, 2013, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with CSC ServiceWorks Holdings, Inc., CSC ServiceWorks, Inc. ("CSC"), Spin Holdco Inc. ("Spin") and CSC Fenway, Inc. ("Merger Sub") that provides for the merger of Mac-Gray with Merger Sub, a wholly-owned subsidiary of Spin, which is a wholly-owned subsidiary of CSC. Pursuant to and upon the closing of the transaction, CSC will acquire all of the outstanding common stock of Mac-Gray for $21.25 per share, payable in cash and the Company will become a wholly-owned subsidiary of Spin. Completion of the transaction is subject to certain closing conditions including the adoption and approval of the merger agreement by Mac-Gray's stockholders, regulatory approval, and other customary closing conditions. Mac-Gray expects the transaction to be completed in the first half of 2014. Following completion of the transaction, Mac-Gray's common stock will be delisted from the New York Stock Exchange and will no longer trade publicly. A description of the Merger Agreement is contained in the Company's current report on Form 8-K filed with the SEC on October 15, 2013, and a copy of the Merger Agreement is filed as Exhibit 2.1 to such report.

Results of Operations (Dollars in thousands)

Three and nine months ended September 30, 2013 compared to three and nine months ended September 30, 2012.

The information presented below for the three and nine months ended September 30, 2013 and 2012 is derived from our unaudited condensed consolidated financial statements and related notes included elsewhere in this report:

                                            For the three months ended September 30,
                                                                     Increase           %
                                       2012            2013         (Decrease)       Change
Laundry facilities management
revenue                            $     74,372    $     75,002    $         630            1 %
Commercial laundry equipment
sales revenue                             3,501           4,509            1,008           29 %
Total revenue                      $     77,873    $     79,511    $       1,638            2 %




                                             For the nine months ended September 30,
                                                                       Increase          %
                                       2012             2013          (Decrease)      Change
Laundry facilities management
revenue                            $     229,316    $     229,357    $         41            0 %
Commercial laundry equipment
sales revenue                             10,620           10,968             348            3 %
Total revenue                      $     239,936    $     240,325    $        389            0 %


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Revenue

Total revenue increased by $1,638, or 2%, to $79,511 for the three months ended September 30, 2013 compared to $77,873 for the three months ended September 30, 2012. Total revenue increased by $389, or less than 1%, to $240,325 for the nine months ended September 30, 2013 compared to $239,936 for the nine months ended September 30, 2012.

Laundry facilities management revenue. Laundry facilities management revenue increased by $630, or 1%, to $75,002 for the three months ended September 30, 2013 compared to $74,372 for the three months ended September 30, 2012. Laundry facilities management revenue increased by $41, or less than 1%, to $229,357 for the nine months ended September 30, 2013 compared to $229,316 for the nine months ended September 30, 2012. The increase in revenue for the three months ended September 30, 2013 compared to the three months ended September 30, 2012 is attributable to the cumulative impact of our vend price management initiatives, same location usage increases, and new equipment placements. The lack of growth in revenue in the nine months ended September 30, 2013 compared to the same period in the prior year is attributable, in part, to there being one additional operating day in 2012 due to it being a leap year. We have also reduced our portfolio of equipment by a small number as compared to the comparable period in 2012, primarily in unprofitable and less profitable locations, which also has resulted in reduced revenue. The reduced revenue was mitigated in part by our vend price management initiatives.

Commercial laundry equipment sales. Revenue in the commercial laundry equipment sales business increased by $1,008, or 29%, to $4,509 for the three months ended September 30, 2013 compared to $3,501 for the three months ended September 30, 2012. Revenue in the commercial laundry equipment sales business increased by $348, or 3%, to $10,968 for the nine months ended September 30, 2013 compared to $10,620 for the nine months ended September 30, 2012. Sales in the commercial laundry equipment sales business are sensitive to the strength of the local economy, the availability and cost of financing to small businesses, consumer confidence, and local permitting and therefore, tend to fluctuate significantly from period to period.

Cost of revenue

                                             For the three months ended September 30,
                                                                      Increase           %
                                        2012            2013         (Decrease)       Change
Cost of laundry facilities
management revenue                  $     52,600    $     53,925    $       1,325            3 %
Depreciation and amortization
related to operations                     10,706          10,878              172            2 %
Cost of commercial laundry
equipment sales                            2,827           3,665              838           30 %
Total cost of revenue               $     66,133    $     68,468    $       2,335            4 %




                                             For the nine months ended September 30,
                                                                      Increase          %
                                        2012            2013         (Decrease)      Change
Cost of laundry facilities
management revenue                  $    160,840    $    161,659    $        819            1 %
Depreciation and amortization
related to operations                     31,536          32,230             694            2 %
Cost of commercial laundry
equipment sales                            8,675           8,932             257            3 %
Total cost of revenue               $    201,051    $    202,821    $      1,770            1 %

Cost of laundry facilities management revenue. Cost of laundry facilities management revenue includes rent paid to clients as well as those costs associated with installing and servicing equipment and costs of collecting, counting, and depositing facilities management revenue. Cost of laundry facilities management revenue increased by $1,325, or 3%, to $53,925 for the three months ended September 30, 2013 as compared to $52,600 for the three months ended September 30, 2012. Cost of laundry facilities management revenue increased by $819, or 1%, to $161,659 for the nine months ended September 30, 2013 as compared to $160,840 for the nine months ended September 30, 2012. As a percentage of laundry facilities management revenue, cost of laundry facilities management revenue was 72% and 71% for the three months ended September 30, 2013 and 2012, respectively, and 70% for each of the nine months ended September 30, 2013 and 2012. Laundry facilities management rent increased by 1%, or $547, to $37,079 for the three months ended September 30, 2013, compared to $36,532 for the three months ended September 30, 2012. Laundry facilities management rent decreased by less than 1%, or $114, to $112,640 for the


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nine months ended September 30, 2013 compared to $112,754 for the nine months ended September 30, 2012, directly attributable to the changes in facilities management revenue. Laundry facilities management rent as a percentage of laundry facilities management revenue was 50.2 % and 49.9 % for the three months ended September 30, 2013 and 2012, respectively, and 49.8 % and 50 % for the nine months ended September 30, 2013 and 2012, respectively. Laundry facilities management rent can be affected by new and renewed laundry leases and by other factors such as the amount of incentive payments and laundry room betterments invested in new or renewed laundry leases. As we vary the amount invested in a facility, the laundry facilities management rent, as a function of laundry facilities management revenue, can vary. Other costs of laundry facilities management revenue increased by $778, or 5%, to $16,846 for the three month ended September 30, 2013 compared to $16,068 for the three months ended September 30, 2012. Other costs of laundry facilities management revenue increased by $933, or 2%, to $49,019 for the nine months ended September 30, 2013 compared to $48,086 for the nine months ended September 30, 2012. These increases were primarily attributable to increases in labor costs and health insurance costs. A significant percentage of other costs of laundry facilities management revenue are fixed costs which do not fluctuate with changes in revenue.

Depreciation and amortization related to operations. Depreciation and amortization related to operations increased by $172, or 2%, to $10,878 for the three months ended September 30, 2013 as compared to $10,706 for the three months ended September 30, 2012. Depreciation and amortization related to operations increased by $694, or 2%, to $32,230 for the nine months ended September 30, 2013 as compared to $31,536 for the nine months ended September 30, 2012. The increase in depreciation and amortization for the three and nine months ended September 30, 2013 as compared to the three and nine months ended September 30, 2012 is attributable to an increase in our capital spending on new and renegotiated accounts beginning in 2012 compared to the two prior years, where we closely managed capital investment in light of the uncertain economy. We expect to continue to increase our capital spending and expect depreciation expense to continue to increase.

Cost of laundry equipment sales. Cost of commercial laundry equipment sales consists primarily of the cost of laundry equipment, parts and supplies sold, as well as salaries, warehousing and distribution expenses. Cost of commercial laundry equipment sales increased by $838, or 30%, to $3,665 for the three months ended September 30, 2013 as compared to $2,827 for the three months ended September 30, 2012. Cost of commercial laundry equipment sales increased by $257, or 3%, to $8,932 for the nine months ended September 30, 2013 as compared to $8,675 for the nine months ended September 30, 2012. As a percentage of sales, cost of product sold was 81% for each of the three months ended September 30, 2013 and 2012, and 81% and 82% for the nine months ended September 30, 2013 and 2012, respectively. The change in cost of sales for the three and nine months ended September 30, 2013 compared to the same period ending September 30, 2012 is a direct result of the change in revenue, product mix and price increases by the manufacturer. Operating expenses were essentially unchanged in total.

Operating expenses

General and administration, sales and marketing, related depreciation and amortization, incremental proxy costs, and transaction costs. General and administration, sales and marketing, related depreciation and amortization, incremental proxy costs, and transaction costs increased by $301, or 4%, to $7,592 for the three months ended September 30, 2013 as compared to $7,291 for the three months ended September 30, 2012. General and administration, sales and marketing, related depreciation and amortization, incremental proxy costs, and transaction costs decreased by $626, or 3%, to $24,318 for the nine months ended September 30, 2013 as compared to $24,944 for the nine months ended September 30, 2012. As a percentage of total revenue, these expenses were 10% and 9% for the three months ended September 30, 2013 and 2012, respectively, and 10% for each of the nine months ended September 30, 2013 and 2012. The increase in expenses for the three months ended September 30, 2013 compared to the same period in 2012 is primarily attributable to costs related to our recently announced agreement for the merger of the Company. The decrease in expenses for the nine months ended September 30, 2013 compared to the same period in 2012 is primarily related to a decrease in legal costs partially offset by an increase in marketing and sales related costs as well as transaction costs.

Gain on sale of assets

The gains of $114 and $57 for the three months ended September 30, 2013 and 2012, respectively, and the gains of $269 and $97 for the nine months ended September 30, 2013 and 2012, respectively, are from the sale of vehicles and other fixed assets in the normal course of business.


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Income from operations

Income from operations decreased by $941, or 21%, to $3,565, for the three months ended September 30, 2013 compared to $4,506 for the three months ended September 30, 2012 and decreased by $583, or 4%, to $13,455 for the nine months ended September 30, 2013 compared to $14,038 for the nine months ended September 30, 2012 due primarily to the cumulative effect of the reasons discussed above.

Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs

Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs, decreased by $784, or 41%, to $1,147 for the three months ended September 30, 2013, as compared to $1,931 for the three months ended September 30, 2012. Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs, decreased by $3,135, or 43%, to $4,100 for the nine months ended September 30, 2013, as compared to $7,235 for the nine months ended September 30, 2012. This decrease in interest expense for the three and nine months ended September 30, 2013 was primarily the result of retiring our 7.625% fixed rate senior notes by utilizing our 2012 Credit Agreement at lower interest rates as well reduced pricing under our 2012 credit agreement and the maturity of our interest rate derivatives. Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, was $1,063 and $1,966 for the three months ended September 30, 2013 and 2012, respectively, a decrease of $903, or 46%. Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, was $4,034 and $7,239 for the nine months ended September 30, 2013 and 2012, respectively, a decrease of $3,205, or 44%. Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, includes interest paid in connection with our derivative instruments through their maturity date. This amounted to $444 for the three months ended September 30, 2012, and $398 and $1,340 for the nine months ended September 30, 2013 and 2012, respectively.

Interest expense associated with the company's long term debt is comprised of the following:

                                       Three months ended            Nine months ended
                                         September 30,                 September 30,
                                      2012           2013           2012           2013

Interest expense                   $     1,966    $     1,063    $     7,239    $    4,034
Change in the fair value of
non-hedged interest rate
derivative instruments                    (125 )            -           (360 )        (196 )
Amortization of deferred
financing costs                             90             84            356           262
Interest expense, including
change in fair value of
non-hedged interest rate
derivative instruments and
amortization of deferred
financing costs                    $     1,931    $     1,147    $     7,235    $    4,100

During the first quarter of 2012, as a result of the senior note redemption (Note 2), the Company no longer qualified for hedge accounting treatment on its only effective interest rate swap agreement. Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost was reclassified as an earnings charge through the maturity date of the derivative. This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $210 for the nine months ended September 30, 2013 compared to $280 and $875 for the three and nine months ended September 30, 2012, respectively.

Loss on early extinguishment of debt

Loss on early extinguishment of debt amounted to $3,762 for the nine months ended September 30, 2012 and includes the premium of $2,542 we incurred for the early redemption of our senior unsecured notes and $1,087 of unamortized deferred financing costs associated with the redemption. We also wrote off $133 of unamortized deferred financing costs associated with our 2008 credit facility. Loss on early extinguishment of

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