FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
____ ACT OF 1934
For the quarterly period ended September 30, 1998
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the transition period from _______ to _______
COMMISSION FILE NUMBER 1-13495
_______
MAC-GRAY CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-3361982
(State or other jurisdiction (I.R.S. Employer
incorporation or organization) Identification No.)
22 WATER STREET, CAMBRIDGE, MASSACHUSETTS 02141
(Address of principal executive offices) (Zip Code)
617-492-4040
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- ----
The number of shares outstanding of each of the issuer's classes of
common stock as of the close date of business on September 30, 1998:
Class Number of shares
----- ----------------
Common Stock, $.01 Par Value 12,813,732
INDEX
-----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 1998
(unaudited) and December 31, 1997
Consolidated Income Statements for the Three and Nine Months
Ended September 30, 1998 and 1997 (unaudited)
Consolidated Statement of Stockholders' Equity for the Nine
Months Ended September 30, 1998 (unaudited)
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1998 and 1997 (unaudited)
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signature
Exhibit Index
Item 1. Financial Statements
MAC-GRAY CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30 DECEMBER 31,
1998 1997
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 8,556 $ 3,774
Trade receivables, net of allowance for doubtful accounts 11,255 6,570
Inventory of finished goods 6,437 7,208
Deferred income taxes 485 571
Prepaid expenses and other current assets 4,736 2,377
-------- --------
Total current assets 31,469 20,500
Property, plant and equipment, net 65,020 43,615
Intangible assets, net 65,205 28,648
Prepaid commissions and other assets 10,341 5,080
-------- --------
Total assets $172,035 $ 97,843
======== ========
LIABILITIES, REDEEMABLE STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1,237 $ 7,922
Current portion of capital lease obligations 761 476
Accounts payable 8,685 7,825
Accrued commissions 7,172 5,585
Accrued expenses 4,286 2,631
Deferred revenues and deposits 5,337 102
-------- --------
Total current liabilities 27,478 24,541
Long-term debt 68,142 5,395
Long-term capital lease obligations 653 491
Deferred income taxes 5,519 5,329
Deferred retirement obligation 989 1,052
Other liabilities 539 429
Commitments and contingencies (Note 6) - -
Redeemable common stock, 612,026 shares 7,797 7,797
Senior redeemable preferred stock - 4,507
Stockholders' equity:
Preferred stock of Mac-Gray Corporation ($.01 par value, 5,000,000 shares
authorized, no shares outstanding) - -
Common stock of Mac-Gray Corporation ($.01 par value, 30,000,000 shares
authorized, 12,813,732 (unaudited) and 12,285,568 shares issued and
outstanding at September 30, 1998 and December 31, 1997, respectively) 128 123
Additional capital 60,576 52,524
Retained earnings (accumulated deficit) 214 (4,345)
-------- --------
Total stockholders' equity 60,918 48,302
-------- --------
Total liabilities, redeemable stock and stockholders' equity $172,035 $ 97,843
======== ========
The accompanying notes are an integral part of these financial statements.
2
MAC-GRAY CORPORATION
CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Pro forma three Pro forma Nine
Three months ended Nine months ended months ended months ended
September 30, September 30, September 30, September 30,
1998 1997 1998 1997 1997 1997
---- ---- ---- ---- ---- ----
Revenue 36,853 23,702 97,710 76,013 28,214 75,956
Cost of revenue:
Commissions 10,596 7,901 29,285 22,540 7,901 22,540
Route expenditures 6,312 2,821 15,345 9,612 2,961 9,426
Depreciation and amortization 3,559 2,459 9,721 6,688 2,272 6,686
Cost of product sales 7,697 4,081 18,699 16,550 7,350 16,377
------ ------ ------ ------ ------ ------
Total cost of revenue 28,164 17,262 73,050 55,390 20,484 55,029
------ ------ ------ ------ ------ ------
Operating expenses:
General and administration 1,557 1,951 5,043 5,148 2,039 5,218
Sales and marketing 2,517 1,956 7,529 6,970 2,504 7,322
Depreciation and amortization 271 300 674 787 315 843
Merger-related costs 884
------ ------ ------ ------ ------ ------
Total operating expenses 4,345 4,207 14,130 12,905 4,858 13,383
------ ------ ------ ------ ------ ------
Income from operations 4,344 2,233 10,530 7,718 2,872 7,544
Interest expense, net (1,317) (991) (2,580) (2,621) (1,070) (2,757)
Other expense, net (117) (68) (118) (29) (68) (29)
------ ------ ------ ------ ------ ------
Income before provision for income taxes 2,910 1,174 7,832 5,068 1,734 4,758
Provision for income taxes 1,259 116 3,154 367 132 367
------ ------ ------ ------ ------ ------
Net income before accretion and dividends on
redeemable preferred stock 1,651 1,058 4,678 4,701 1,602 4,391
------ ------ ------ ------ ------ ------
Accretion and dividends on redeemable preferred
stock - 80 62 240 80 240
------ ------ ------ ------ ------ ------
Net income available to common stockholders 1,651 978 4,616 4,461 1,522 4,151
====== ====== ====== ====== ====== ======
Net income per common share - basic 0.13 0.13 0.37 0.59 0.20 0.55
====== ====== ====== ====== ====== ======
Weighted average common shares outstanding 12,654 7,554 12,479 7,554 7,554 7,554
====== ====== ====== ====== ====== ======
Net income per common share - diluted 0.13 0.12 0.36 0.57 0.19 0.53
====== ====== ====== ====== ====== ======
Weighted average common shares outstanding -
diluted 13,011 7,919 12,897 7,838 7,919 7,838
====== ====== ====== ====== ====== ======
Pro forma tax adjusted data (Note 7):
Income before provision for income taxes 1,174 5,068 1,734 4,758
Provision for income taxes 470 2,027 694 1,903
------ ------ ------ ------
Pro forma tax adjusted net income 704 3,041 1,040 2,855
====== ====== ====== ======
Pro forma tax adjusted net income available to
common stockholders 624 2,801 960 2,615
====== ====== ====== ======
Pro forma tax adjusted net income available to
common stockholders per common share 0.08 0.37 0.13 0.35
====== ====== ====== ======
Pro forma tax adjusted net income available to
common stockholders per common share -
diluted 0.08 0.36 0.12 0.33
====== ====== ====== ======
The accompanying notes are an integral part of these financial statements
3
MAC-GRAY CORPORATION
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)
(IN THOUSANDS, EXCEPT SHARE DATA)
Common stock Retained
------------
Number of Additional Earnings
Shares Value capital (deficit) Total
------ ----- ------- --------- -----
Balance, December 31, 1997 12,285,568 $ 123 $ 52,524 $ (4,345) $ 48,302
Net income available to common
stockholders - - - 4,616 4,616
Inclusion of Intirion's net equity
activity for the Six Months Ended
December 31, 1997 - - (13) 15 2
Exchange of Intirion preferred
shares for Mac-Gray common
stock 275,224 3 3,821 - 3,824
Shares of Mac-Gray Common stock
issued in conjunction with the
acquisition of Copico 250,000 2 4,216 4,218
Intirion dividends paid - - - (72) (72)
Options exercised 2,940 - 28 - 28
----------------------------------------------------------------------
Balance, September 30, 1998 12,813,732 $ 128 $ 60,576 $ 214 $ 60,918
======================================================================
The accompanying notes are an integral part of these financial statements
4
MAC-GRAY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(IN THOUSANDS, EXCEPT SHARE DATA)
Nine Months Ended
September 30,
-----------------------------
1998 1997
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income 4,678 4,701
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 10,395 7,475
Loss on sale of assets 38 62
Deferred income taxes 277 93
(Increase) decrease in accounts receivable (4,377) 555
Decrease (increase) in inventory 2,962 (498)
Increase in prepaid expenses and other assets (8,852) (3,327)
Increase (decrease) in accounts payable,
accrued commissions and accrued expenses 5,138 (3,259)
Increase in deferred revenues and deposits 2,785 1,285
--------- --------
Net cash flows provided by operating
activities 13,044 7,087
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (15,224) (8,353)
Acquisition of businesses, net of cash acquired (50,106) (4,958)
Proceeds from sales of property and
equipment 1,712 637
--------- --------
Net cash flows used in investing
activities (63,618) (12,674)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt and
capital lease obligations (1,150) (3,224)
Principal payments on deferred retirement obligations (63) (76)
Retirement of line of credit and term loan - (18,646)
Advances on credit facility, net of debt assumed 56,613 32,335
Contribution of capital and proceeds from sale of common stock 28 -
Cash dividends paid (72) (3,724)
--------- --------
Net cash flows provided by financing
activities 55,356 6,665
--------- --------
Increase in cash and cash
equivalents 4,782 1,078
Cash and cash equivalents, beginning of period 3,774 2,844
--------- --------
Cash and cash equivalents, end of period 8,556 3,922
========= ========
Supplemental Information:
No cash adjustment is reflected in the 1998 amounts for the period July 1
through December 31, 1997 for Intirion, since Intirion's ending cash balance at
June 30, 1997 and December 31, 1997 was $0.
The accompanying notes are an integral part of these financial statements
5
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1. BASIS OF PRESENTATION
In the opinion of management of Mac-Gray Corporation (the "Company" or "Mac-
Gray"), the accompanying unaudited consolidated financial statements contain all
adjustments (consisting of only normal, recurring adjustments) which are, in the
opinion of management, necessary to present fairly the Company's financial
position as of September 30, 1998 and December 31, 1997 and the results of its
operations and cash flows for the three and nine month periods ended September
30, 1998 and 1997. The unaudited interim consolidated financial statements do
not include all information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles. These unaudited consolidated financial statements should be read in
conjunction with the Company's fiscal 1997 audited consolidated financial
statements filed with the Securities and Exchange Commission in its Annual
Report on Form 10-K and in conjunction with the Company's restated fiscal 1997
audited consolidated financial statements filed with the SEC in the Registration
Statement on Form S-1 filed on June 10, 1998, as amended, which were restated as
a result of the acquisition of Intirion Corporation which was accounted for as a
pooling of interests. The results for interim periods are not necessarily
indicative of the results to be expected for the full year.
On March 12, 1998, Intirion Corporation ("Intirion") was acquired by Mac-Gray in
a transaction accounted for as a pooling of interests. The accompanying
consolidated financial statements have been prepared to give retroactive effect
to the pooling transaction and include the accounts of Mac-Gray, Intirion and
their respective wholly owned subsidiaries. Mac-Gray issued 1,593 shares of
common stock and paid $1,033 in cash in exchange for all of the outstanding
equity securities of Intirion. Costs directly associated with the pooling
transaction of $884 were incurred in the three months ended March 31, 1998.
These costs include legal, accounting and severance costs directly associated
with the pooling transaction and are classified as merger-related costs on the
income statement.
Due to the differing year ends of Mac-Gray and Intirion, financial information
for dissimilar periods has been combined in the consolidated financial
statements. As such, the historical annual financial statements were restated
by combining the June 30 financial statements of Intirion with the December 31
financial statements of Mac-Gray. Intirion's results of operations for its
three and nine months ended March 31, 1997 were combined with Mac-Gray's results
of operations for the three and nine months ended September 30, 1997, and
Intirion's balance sheet at June 30, 1997 was combined with Mac-Gray's balance
sheet at December 31, 1997. Pro forma consolidated results of operations for
the three and nine months ended September 30, 1997 have also been presented.
Pro forma consolidated data reflects the results of operations for the three and
nine months ended September 30, 1997 for Mac-Gray consolidated with the three
and nine months ended September 30, 1997 for Intirion and has been presented for
informational purposes.
6
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
No adjustments to the net assets of the combining companies were required to
adopt the same accounting practices and there were no intercompany transactions
between Mac-Gray and Intirion prior to the combination. During the previous
quarter, an adjustment was required to record Intirion's net equity activity for
the six months ended December 31, 1997 in order to change the fiscal year of
Intirion from June to December. This adjustment is presented on the
consolidated statement of stockholders' equity.
The following table reconciles the revenues and net income previously reported
by Mac-Gray prior to the Intirion combination to the results currently reported
in the 10-Q.
Three Months Ended
-----------------------------------------------------------
September 30, 1997 March 31, 1997 September 30, 1997
Mac-Gray Intirion as Reported
-------- -------- -----------
Net Revenues $19,879 $ 3,824 $23,702
Net Income (loss) $ 1,063 $ (5) $ 1,058
Nine Months Ended
-----------------------------------------------------------
September 30, 1997 March 31, 1997 September 30, 1997
Mac-Gray Intirion as Reported
-------- -------- -----------
Net Revenues $58,167 $17,846 $76,013
Net Income $ 4,095 $ 606 $ 4,701
Pro Forma Three Months Ended
-----------------------------------------------------------
September 30, 1997 September 30, 1997 September 30, 1997
Mac-Gray Intirion as Reported
-------- -------- -----------
Net Revenues $19,879 $ 8,334 $28,214
Net Income $ 1,063 $ 537 $ 1,602
Pro Forma Nine Months Ended
-----------------------------------------------------------
September 30, 1997 September 30, 1997 September 30, 1997
Mac-Gray Intirion as Reported
-------- -------- -----------
Net Revenues $58,167 $17,789 $75,956
Net Income $ 4,095 $ 296 $ 4,391
2. LONG TERM DEBT
On April 23, 1998, the outstanding debt under the 1997 Credit Facility was
refinanced under a new revolving line of credit and term loan facility (the
"1998 Senior Secured Credit Facility"). The 1998 Senior Secured Credit Facility
provides for borrowings under a revolving line of credit of up to $90,000, and
converts to a term loan after three years for the outstanding balance at the
date of conversion. Outstanding indebtedness under the 1998 Senior Secured
Credit Facility bears interest, at the Company's option, at a rate equal to the
prime rate minus .5% or LIBOR plus the Applicable Margin (either (i) 1.5% for
loans outstanding which aggregate less than $50,000, or (ii) 1.75% for loans
outstanding which exceed $50,000), or Cost of Funds (COF) plus the Applicable
Margin.
7
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The 1998 Senior Secured Credit Facility restricts payments of dividends and
other distributions, restricts the Company from making certain acquisitions and
incurring indebtedness, and requires it to maintain certain financial ratios.
The 1998 Senior Secured Credit Facility is secured by a blanket lien on the
assets of the Company and each of its subsidiaries, as well as a pledge by the
Company of all of the capital stock of its subsidiaries. The balance
outstanding under the 1998 Senior Secured Credit Facility was $63,596 at
September 30, 1998.
Through Intirion, the Company had outstanding borrowings of $0 at September 30,
1998 and $2,525 at December 31, 1997. All outstanding borrowings of Intirion
Corporation were repaid by Mac-Gray subsequent to the merger and Intirion's line
of credit agreement was terminated.
Long term debt also includes various notes payable totaling $3,877 at September
30, 1998 and $4,538 at December 31, 1997, and various unsecured notes payable to
former shareholders totaling $1,906 at September 30, 1998 and $2,560 at December
31, 1997.
3. MERGERS AND ACQUISITIONS
On April 23, 1998, Mac-Gray acquired one hundred percent of the outstanding
capital stock of Copico, Inc. ("Copico"). Copico is a provider of card and
coin-operated reprographics equipment and services to the academic and public
library markets in New England, New York and Florida. The purchase price was
250 shares of Mac-Gray common stock and $10,950 in cash, less the assumption of
certain debt. The acquisition was accounted for as a purchase transaction.
Assuming this acquisition had occurred at January 1, 1997 the pro forma results
of operations would not have differed materially from the results of operations
reported.
On April 24, 1998, Mac-Gray acquired one hundred percent of the outstanding
capital stock of Amerivend Corporation and the assets of Amerivend Southeast
Corporation for approximately $33,500 in cash, including the payment of certain
debt. Amerivend is a provider of card and coin-operating laundry rooms in
multiple housing facilities. The acquisition was accounted for as a purchase
transaction.
The unaudited September 30, 1998 financial statements include the results of
Copico and Amerivend for the period subsequent to the dates of their respective
acquisition. Goodwill and other intangible assets amounting to approximately
$37,000 was recorded in connection with these acquisitions.
The following supplemental pro forma financial information reflects the
Amerivend acquisition as if it occurred on January 1, 1997.
Unaudited Unaudited
Supplemental Pro Supplemental Pro
Forma Results for Forma Results for
the Nine Months the Nine Months
Ended Ended
September 30, 1998 September 30, 1997
------------------------------------------
Revenue $ 103,808 $ 89,144
Net Income $ 5,206 $ 5,260
Pro Forma tax adjusted net income
available to common stockholders $ 4,933 $ 3,495
Pro Forma tax adjusted net income
Per Share $ 0.40 $ 0.46
Pro Forma tax adjusted net income
Per Share - diluted $ 0.38 $ 0.45
8
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
4. DEFERRED RETIREMENT OBLIGATION
The deferred retirement obligation at September 30, 1998 and December 31, 1997
relates to payments due to a former shareholder of the Company in connection
with a retirement agreement which provides for annual payments of $104 until the
death of the former shareholder. The liability at September 30, 1998 and
December 31, 1997 has been estimated based upon the life expectancy of the
former shareholder utilizing actuarial tables.
5. INCOME TAXES
The results of operations for the nine months ended September 30, 1998 include a
tax benefit of $370 due to the release of a valuation allowance, during the
three months ended June 30, 1998, on certain tax assets available for use by
Intirion. Based on the results of operations of Intirion subsequent to the
combination, management believes that it is more likely than not that such
assets will be realized.
6. COMMITMENTS AND CONTINGENCIES
Guarantee of Indebtedness--At December 31, 1997, Mac-Gray Co., Inc. was a
guarantor on a line of credit for a customer in the amount of $706, and recorded
a contingency reserve of $250 for estimated losses on the guarantee. The
guarantee was secured by a pledge of the borrowing company's assets. During the
three months ended March 31, 1998, the customer defaulted on the line of credit
and the Company succeeded to the assets and assumed the liabilities of the
customer in accordance with the guarantee and related agreements. At March 31,
1998, the fair market value of the customer's assets and a liability of $677
were recorded on the Company's financial statements and a loss was recorded
against the reserve. In April 1998, the customer's liability to its creditor
was paid in full by Mac-Gray.
7. PRO FORMA TAX ADJUSTED DATA
Pro forma tax adjusted data reflects adjustments to the consolidated statements
of income for the three and nine months ended September 30, 1997. Such
adjustments consider the effect of the Company's operations as if the Company
was subject to federal and state income taxes on a corporate level. Prior to
the Company's initial public offering, it operated as a Subchapter S
corporation. As such, its income was not subject to federal taxation at the
corporate level. The pro forma income tax provision and pro forma net income
have been calculated as if the Company was subject to income taxation as a C
corporation during the entire year at an assumed effective tax rate of 40%.
8. EARNINGS PER SHARE
Mac-Gray adopted Statement of Financial Accounting Standards No. 128, "Earnings
Per Share" (SFAS 128) in 1997. In conjunction with the adoption of this
standard, Mac-Gray has complied with Staff Accounting Bulletin No. 98 (SAB 98)
issued by the Securities and Exchange Commission. Accordingly, earnings per
share data have been restated for all periods presented to give effect to both
pronouncements.
9
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the Three Months Ended September 30, 1998
Per-
Income Shares Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Net income per common share:
Net Income $ 1,651
Less: Accretion and dividends on redeemable preferred stock -
------------
Net income available to common stockholders $ 1,651 12,654 $ 0.13
============ =============== ==========
Effect of dilutive securities:
Stock options 198
Contingent shares 159
---------------
Net income available to common stockholders--diluted $ 1,651 13,011 $ 0.13
============ =============== ==========
For the Three Months Ended September 30, 1997
Per-
Income Shares Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Net income per common share:
Net Income $ 1,058
Less: Accretion and dividends on redeemable preferred stock 80
------------
Net income available to common stockholders $ 978 7,554 $ 0.13
============ =============== ==========
Effect of dilutive securities:
Stock options 233
Contingent shares 132
---------------
Net income available to common stockholders--diluted $ 978 7,919 $ 0.12
============ =============== ==========
For the Nine Months Ended September 30, 1998
Per-
Income Shares Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Net income per common share:
Net Income $ 4,678
Less: Accretion and dividends on redeemable preferred stock 62
------------
Net income available to common stockholders $ 4,616 12,479 $ 0.37
============ =============== ==========
Effect of dilutive securities:
Stock options 259
Contingent shares 159
---------------
Net income available to common stockholders--diluted $ 4,616 12,897 $ 0.36
============ =============== ==========
10
MAC-GRAY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the Nine Months Ended September 30, 1997
Per-
Income Shares Share
(Numerator) (Denominator) Amount
------------ --------------- ----------
Net income per common share:
Net Income $ 4,701
Less: Accretion and dividends on redeemable preferred stock 240
------------
Net income available to common stockholders $ 4,461 7,554 $ 0.59
============ =============== ==========
Effect of dilutive securities:
Stock options 152
Contingent shares 132
---------------
Net income available to common stockholderS--diluted $ 4,461 7,838 $ 0.57
============ =============== ==========
9. NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 130. "Reporting Comprehensive Income" (SFAS 130) in
June 1997. The Company adopted SFAS 130 for fiscal 1998. SFAS requires
presentation of certain information related to comprehensive income. For the
three months ended September 30, 1998 and 1997, the Company had no other
comprehensive income as defined by SFAS 130, therefore there is no impact on the
Company's balance sheet and income statement.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (SFAS 131), which requires that certain additional
information related to operating segments be reported. The Company will be
required to disclose segment information on the same basis that is used
internally for evaluating segment performance for the fiscal year ending
December 31, 1998.
11
Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains, in addition to historical information, forward-
looking statements that involve risks and uncertainties. The Company's actual
results could differ significantly from the results discussed in the forward-
looking statements. Factors that could cause or contribute to such differences
include: implementation of acquisition strategy; integration of acquired
businesses; ability to meet future capital requirements; dependence upon certain
suppliers; lease renewals; retention of senior executives; market acceptance of
new products and services; and those factors discussed in Mac-Gray's filings
with the Securities and Exchange Commission ("SEC"). The historical financial
information presented herein represents the consolidated results of Mac-Gray
including the consolidated results of Intirion for all periods presented. The
following discussion and analysis should be read in conjunction with the
financial statements and related notes thereto presented elsewhere in this
report and with the annual financial statements and related notes previously
filed by Mac-Gray with the SEC on its Annual Report on Form 10-K.
OVERVIEW
Mac-Gray derives its revenue principally through the operation and maintenance
of card and coin-operated laundry rooms in multiple housing facilities, such as
apartment buildings, colleges and universities, condominiums and public housing
complexes. Mac-Gray operates its laundry rooms under long-term leases with
property owners, colleges and universities and governmental agencies. The
leases typically grant Mac-Gray the exclusive right to operate laundry rooms on
the lessor's premises for a fixed term, which is generally seven to ten years,
in exchange for a percentage of the revenue collected. Mac-Gray's Laundry Route
business consists of approximately 155,000 laundry machines, operated in over
25,000 multiple housing laundry rooms located in 27 states.
Mac-Gray also derives revenue as a distributor and servicer of commercial
laundry equipment manufactured by Maytag Corporation, and sells laundry
equipment manufactured by American Dryer, The Dexter Company, and Whirlpool
Corporation to provide several alternatives in machine type, cost and capacity.
Additionally, the Company sells or rents laundry equipment to restaurants,
hotels, health clubs and similar institutional users that operate their own on-
premise laundry facilities.
RECENT DEVELOPMENTS
On March 12, 1998, Mac-Gray completed its acquisition of Intirion, which has
been accounted for as a pooling of interests. Through Intirion, the Company
sells its proprietary MicroFridge(R) product which is a combination
refrigerator/freezer/microwave oven utilizing patented circuitry. The product
is marketed throughout the United States to colleges and universities, the
federal government, mid range hotels and motels and to builders of assisted
living facilities. All of Intirion's products are manufactured by outside
suppliers. In addition, Intirion also rents its products on a year to year
basis to students living in college and university residence halls or through
long term leases directly with the universities.
Mac-Gray acquired one hundred percent of the capital stock of Copico, Inc.
(Copico) on April 23, 1998 for 250,000 shares of Mac-Gray common stock and
$10.95 million in cash, less the assumption of certain debt. Founded in 1978,
Copico is a major provider of card and coin-operated reprographics equipment and
services to the academic and public library markets in New England, New York,
Florida and Texas. Copico provides and services copiers, laser printers and
microform reader-printers for the libraries of colleges, universities and
graduate schools. Copico also is the sole provider of reprographics services to
the New York public library system, as well as other public libraries. Copico
had revenues of approximately $7.1 million for its fiscal year ended January 31,
1998 and has operations facilities in Canton, Massachusetts, New York, New York,
and Miramar, Florida. Mac-Gray funded the cash portion of the purchase price by
drawing on the 1998 Senior Secured Credit Facility. See "Liquidity and Capital
Resources".
12
Mac-Gray acquired one hundred percent of the outstanding capital stock of
Amerivend Corporation and the assets of Amerivend Southeast Corporation
(collectively, Amerivend) on April 24, 1998 for approximately $33.5 million in
cash, including the payment of certain debt. Amerivend is a provider of card
and coin-operated laundry equipment in Florida and Georgia. Amerivend is also
the principal distributor of Maytag commercial laundry products in Alabama,
Georgia and Florida. Founded in 1959, Amerivend had 1997 revenues of $18.6
million and has offices in Miami, Orlando, and Tampa, Florida and Atlanta,
Georgia. The purchase price was funded by drawing on the 1998 Senior Secured
Credit Facility. See "Liquidity and Capital Resources".
The Company's Board of Directors has approved a Stock Repurchase Plan under
which Mac-Gray is authorized to acquire up to one million (1,000,000) shares of
its outstanding Common Stock in the open market during the next 12 months.
Under the Plan, shares may be repurchased from time to time and in such amounts
as market conditions warrant, and subject to regulatory considerations. The
total number of shares subject to repurchase under the Plan is subject to
approval by Mac-Gray's senior lenders.
YEAR 2000
The Company is aggressively researching and testing potential year 2000 problems
in its software and systems. Toward that end the Company has enlisted the aid
of an outside consulting firm to assist in the identification of any year 2000
issues. The consultants are expected to present their findings to the Company
on or before November 30, 1998. The cost for this service has been estimated at
$35,000, all of which will be incurred and expensed in the fourth quarter of
1998. The Company will be unable to estimate costs or establish timelines for
any items of noncompliance that may be identified by the consultants until
receipt of the consultant's report.
The Company has previously identified some software that is not presently year
2000 compliant. This software is in various stages of being updated to be in
compliance with year 2000 requirements. Based on current schedules it is
anticipated that this updating will be completed, tested, and operational before
the end of the second quarter of 1999. The software is primarily being re-
written by in-house programming staff and the necessary resources have been
allocated from operating budgets to complete the system in a timely manner. No
material additional expenditures are anticipated to complete these projects and
the allocation of these resources is not expected to prohibit the completion of
other less significant projects. The Company cannot presently determine the
impact on its business, results of operations, or financial condition should the
re-writes meet unexpected delays and not be completed by December 31, 1999.
The Company has made preliminary evaluations of its customer's year 2000
compliance. The Company believes that most of its customer's will not be
materially impacted by year 2000 issues. Those customers who may be impacted
consist primarily of finance companies and other commercial lending institutions
through which the Company often receives payment on significant equipment sales.
The Company does not foresee any significant problems with these companies and
is working with them to resolve any potential problems. The Company believes
that in the event any or all finance companies suffer problems due to non-
compliance with year 2000 issues, the Company may experience a delay in payment
on sales for which products have already been delivered. While these sales may
be individually significant they are not material to the overall results of
operations of the Company. The Company expects to complete its assessment of
customer's year 2000 compliance issues by the end of 1998.
The Company is working with its primary vendors to identify and resolve any year
2000 compliance issues. At this time no issues have been identified and the
Company does not foresee any significant issues developing. Should any year
2000 issues arise with any primary vendors that result in extended delays of
shipments of equipment to the Company, the Company could be forced to delay the
installation or sale of equipment. The Company could also be forced to delay
required maintenance where parts are required. The Company expects to confirm
the year 2000 readiness of all primary vendors before the end of the first
quarter of 1999.
The Company has invested heavily in smart card technology where the year 2000
compatibility is not yet confirmed. Smart card technology includes software and
hardware systems which the Company uses to provide cashless interaction with
laundry, reprographic, vending, and door access equipment. The software and
hardware systems include credit card sized devices with imbedded CPU's and
related equipment which can add value or authorize use through various
electronic reading devices installed in or near the related amenities. The
Company is working with its suppliers to ensure that the current technology is
year 2000 compliant and at this time does not foresee any problems. The
Company does not expect to incur significant costs to resolve any issues in this
area and expects to confirm the year 2000 readiness of its smart card technology
by the end of 1998.
The Company does not presently have any contingency plans in place for
unresolved year 2000 issues. At this time all identified year 2000 issues are
being resolved under timelines which the Company believes will more than
adequately provide for unknowns and delays. Should any issues be identified in
the coming months which the Company believes could remain unresolved into the
latter stages of 1999 the Company will begin to develop contingency plans.
13
RESULTS OF OPERATIONS (IN THOUSANDS)
Due to the differing year ends of Mac-Gray and Intirion prior to the
combination, the three months ended September 30, 1997 represents consolidated
results for the period from July, 1997 through September, 1997 for Mac-Gray
consolidated with the three month period from January, 1997 through March, 1997
for Intirion. The nine months ended September 30, 1997 represent the
consolidated results for the period January through September 1997 for Mac-Gray
consolidated with the nine month period July 1996 through March 1997 for
Intirion. The pro forma three months ended September 30, 1997 represents
consolidated results for the period from July, 1997 through September, 1997 for
both Mac-Gray and Intirion. The three months ended September 30, 1998
represents consolidated results for the period from July, 1998 through
September, 1998 for both Mac-Gray and Intirion. The pro forma nine months ended
September 30, 1997 represent consolidated results for the period from January,
1997 through September 1997 for both Mac-Gray and Intirion.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997 AND PRO FORMA THREE MONTHS ENDED SEPTEMBER 30, 1997.
Revenue. Revenue increased by $13,151, or 55%, to $36,853 for the three months
ended September 30, 1998 from the three months ended September 30, 1997 and
increased by $8,639, or 31%, from the pro forma three months ended September 30,
1997. This increase is related to an increase in Route Revenue, which is made
up of money collected through coin- and card-operated equipment, of $7,953, or
49%, from the three months and pro forma three months ended September 30, 1997
due to the expansion of existing operations and the additional revenues from the
route businesses acquired during 1998. Sales Revenue increased $5,513, or 92%,
from the three months ended September 30, 1997, due to comparison of dissimilar
periods where seasonal sales fluctuations are cause distortions.
Commissions. Commissions increased by $2,695, or 34%, to $10,596 for the three
months ended September 30, 1998 from the three months and pro forma three months
ended September 30, 1997. This overall increase was primarily attributable to
an increase in Route Revenue, since commissions are generally paid based upon a
percentage of revenue earned in the Company's route locations. The slower rate
of increase relative to Route Revenue was attributable to average commission
rates on accounts acquired through acquisition during 1998 being lower than on
accounts which existed in 1997. The Company believes that it is likely that
overall commissions relative to revenue will stabilize during the next few
quarters and then adjust proportionately with Route Revenue.
Route Expenditures. Route expenditures include costs associated with installing
and servicing machines, as well as the costs of collecting, counting and
depositing the revenue. Route expenditures increased by $3,491, or 124%, to
$6,312 for the three months ended September 30, 1998 from the three months ended
September 30, 1997 and increased by $3,351, or 113% from the pro forma three
months ended September 30, 1997. The increase was due in part to the general
increase in revenue, which resulted in increased servicing, collecting, counting
and depositing activity, and to the addition of branch locations as a result of
acquisitions. The increase was also attributable to acquisitions made during
1998 for which the fixed and variable cost mix associated with route
expenditures is different and causes increases in route expenditures relative to
route revenue to rise during the slower periods of the year, including June
through August.
14
Depreciation and Amortization. Depreciation and amortization include amounts
included as a component of cost of revenue, and amounts included as an operating
expense. Aggregate depreciation and amortization increased by $1,071, or 39%,
to $3,830 for the three months ended September 30, 1998 from the three months
ended September 30, 1997 and increased $1,243, or 48%, from the pro forma three
months ended September 30, 1997. The increase was primarily attributable to the
acquisitions of businesses during 1998 which resulted in additional machines to
depreciate, as well as an increase in intangible assets to amortize,
depreciation also increased as a result of the increase in the Company's machine
base due to internal growth.
General and Administration. General and administration expenses decreased by
$394, or 20%, to $1,557 for the three months ended September 30, 1998 from the
three months ended September 30, 1997 and decreased by $482, or 24%, from the
pro forma three months ended September 30, 1997. The decrease is primarily
related to significant payroll cost reductions in the Intirion division through
the elimination of duplicate positions.
Sales and marketing. Sales and marketing expense increased $561, or 29%, to
$2,517 for the three months ended September 30, 1998 from the three months ended
September 30, 1997. The increase is related to growth in the sales and
marketing staff, which began to take place in 1997 as territories expanded and
marketing staff were added so projects could be completed in-house. The
increase from the three months ended September 30, 1997 is distorted by the
comparison of dissimilar periods.
Interest Expense. Interest expense, net of interest income, increased by $326,
or 33%, to $1,317 for the three months ended September 30, 1998 from the three
months ended September 30, 1997 and increased by $247, or 23%, from the pro
forma three months ended September 30, 1997. This increase is primarily related
to an increase in outstanding borrowings which are related to the significant
acquisition activity in the second quarter of 1998.
Income Tax Expenses. The increase in income tax expense is due to the
termination of Mac-Gray's S corporation status concurrent with the Company's
initial public offering in October 1997 (the "IPO"). Upon termination of the
S corporation status, Mac-Gray became subject to federal and state income taxes,
as such the effective tax rate increased from approximately 9% to approximately
40%.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 1997 AND PRO FORMA NINE MONTHS ENDED SEPTEMBER 30, 1997.
Revenue. Revenue increased by $21,697, or 29%, to $97,710 for the nine months
ended September 30, 1998 from the nine months ended September 30, 1997 and
increased by $21,754, or 29% for the pro forma nine months ended September 30,
1997. This increase is related primarily to an increase in Route Revenue of
$17,668, or 37%, from the nine months and pro forma nine months ended September
30, 1997 due to the expansion of existing operations and the additional revenues
from the route businesses acquired during 1998.
Commissions. Commissions increased by $6,745, or 30%, to $29,285 for the nine
months ended September 30, 1998 from the nine months and pro forma nine months
ended September 30, 1997. This overall increase was primarily attributable to
an increase in Route Revenue, since commissions are generally paid based upon a
percentage of revenue earned in the Company's route locations.
15
Route Expenditures. Route expenditures include costs associated with installing
and servicing machines, as well as the costs of collecting, counting and
depositing the revenue. Route expenditures increased by $5,733, or 60%, to
$15,345 for the nine months ended September 30, 1998 from the nine months ended
September 30, 1997 and increased by $5,919, or 63% from the pro forma nine
months ended September 30, 1997. The increase was due in part to the general
increase in revenue, which resulted in increased servicing, collecting, counting
and depositing activity, and to the addition of branch locations as a result of
acquisitions. The increase was also attributable to acquisitions made during
1998 for which the fixed and variable cost mix associated with route
expenditures is different and causes increases in route expenditures relative to
route revenue to rise during the slower periods of the year, including June
through August.
Depreciation and Amortization. Depreciation and amortization include amounts
included as a component of cost of revenue, and amounts included as an operating
expense. Aggregate depreciation and amortization increased by $2,920, or 39%,
to $10,395 for the nine months ended September 30, 1998 from the nine months
ended September 30, 1997 and increased $2,866, or 38%, from the pro forma nine
months ended September 30, 1997. The increase was primarily attributable to the
acquisitions of businesses during 1998, which resulted in additional machines to
depreciate, as well as an increase in intangible assets to amortize.
Depreciation also increased as a result of the increase in the Company's machine
base due to internal growth.
Interest Expense. Interest expense, net of interest income, decreased by $41,
or 2%, to $2,580 for the nine months ended September 30, 1998 from the nine
months ended September 30, 1997 and decreased by $177, or 6%, from the pro forma
nine months ended September 30, 1997. This increase is primarily related to an
increase in outstanding borrowings related to the significant acquisition
activity in the second quarter of 1998.
A portion of the net proceeds received from the Company's IPO were used to
reduce the existing indebtedness of the Company under the 1997 Credit Facility
and resulted in reduced interest expense for the first quarter of 1998.
Merger-Related Costs. One-time, non-recurring costs associated with the
acquisition of Intirion, which was accounted for as a pooling transaction,
totaled $884 in the nine months ended September 30, 1998.
Income Tax Expense. The increase in income tax expense is due to the
termination of Mac-Gray's S corporation status concurrent with the IPO. Upon
termination of the S corporation status, Mac-Gray became subject to federal and
state income taxes, as such the effective tax rate increased from approximately
9% to approximately 40%. The results of operations for the nine months ended
September 30, 1998 include a tax benefit of $370,000 due to the release of a
valuation allowance on certain tax assets available for use by Intirion. Based
on the results of operations of Intirion subsequent to the combination,
management believes that it is more likely than not that such assets will be
realized.
SEASONALITY
The Company experiences moderate seasonality as a result of its significant
operations in the college and university market. Revenues derived from the
college and university market represent approximately thirty-five percent (35%)
of the Company's total revenue. Route and rental revenues are derived
substantially during the school year which includes the first, second and fourth
calendar quarters. Conversely, the Company increases its operating expenditures
during the third calendar quarter when colleges and universities are not in
session as a result of Mac-Gray's increased product installation activities.
Product sales, principally MicroFridge(R), to this market are also high during
the third calendar quarter.
16
LIQUIDITY AND CAPITAL RESOURCES
Mac-Gray's primary sources of cash since December 31, 1997 have been operating
activities and bank borrowings. The Company's primary uses of cash have been
business acquisitions, capital expenses including the purchase of new laundry
machines, MicroFridge equipment, and smart card based payment systems. The
Company anticipates that it will continue to use cash flow from its operating
activities to finance working capital needs, including interest payments on any
outstanding indebtedness, as well as capital expenditures. Funds available
under the 1998 Senior Secured Credit Facility were used as needed to finance the
acquisitions of Amerivend and Copico. The Company also anticipates that it will
use additional funds available to it under the 1998 Senior Secured Credit
Facility to finance additional possible acquisitions, larger capital
expenditures, the stock buyback program and, as needed, working capital.
Cash flows provided by operations were $13,044 and $7,087 for the nine months
ended September 30, 1998 and 1997, respectively. Cash flow from operations
consists primarily of route revenue, product sales, laundry equipment service
revenue, and rental revenue, commissions, route expenditures, cost of product
sales, cost of rental revenue, general and administration expenses and sales and
marketing expenses. The Company also incurred costs as a result of the Mac-Gray
and Intirion pooling transaction.
Cash used in investing activities was $63,618 and $12,674 for the nine months
ended September 30, 1998 and 1997 respectively. Mac-Gray invested
approximately $50,106, in connection with 1998 acquisitions, primarily Amerivend
and Copico. Capital expenditures were $15,224 and $8,353 for the nine months
ended September 30, 1998 and 1997, respectively.
Net cash flows from financing activities were $55,356 and $6,665 for the nine
months ended September 30, 1998 and 1997, respectively. Financing activities
for those periods consist primarily of proceeds from and repayments of bank
borrowings, capital stock transactions, and payments of dividends. The increase
is a result of borrowings used to fund the Amerivend and Copico acquisitions in
1998.
On April 23, 1998, the Company refinanced the amounts outstanding under the 1997
Credit Facility with the proceeds of the 1998 Senior Secured Facility. The 1998
Senior Secured Credit Facility provides for borrowings under a revolving line of
credit of up to $90,000,000, and converts to a term loan after three years. The
term loan has a weighted five year amortization schedule with a balloon payment
due after the second year of the term loan. Outstanding indebtedness under the
1998 Senior Secured Credit Facility bears interest at the Company's option, at a
rate equal to the prime rate minus .5% or LIBOR plus the applicable margin
(either (i)1.5% for loans outstanding which aggregate less than $50,000,000, or
(ii) 1.75% for loans outstanding which exceed $50,000,000), or the Cost of Funds
(COF) rate plus the applicable margin. The 1998 Senior Secured Credit Facility
imposes certain financial and operational covenants on the Company, including
restrictions on indebtedness, certain capital expenditures, investments and
acquisitions and on the Company's ability to pay dividends and to make
distributions. The 1998 Senior Secured Credit Facility, under certain limited
circumstances, also restricts the payment of dividends and other distributions
as well as certain acquisitions and investments. The 1998 Senior Secured Credit
Facility is secured by a blanket lien on the assets of the Company and each of
its subsidiaries, as well as a pledge by the Company of all of the capital stock
of its subsidiaries. The Company was in compliance with the terms of the credit
agreement as of September 30, 1998.
In connection with the acquisition of Sun Services of America, Inc. in April,
1997, the Company issued 612,026 shares of redeemable common stock to the owner
of Sun Services. The Company remains obligated to repurchase shares of Common
Stock at a price of $12.74 per share in the event the holder or holders of such
shares elect to exercise such rights. These rights expire on October 21, 2000.
In the event such rights are exercised, the Company would likely fund the
purchase price for such shares of Common Stock by incurring additional
indebtedness under the 1998 Senior Secured Credit Facility.
17
The Company believes that the amount available under the 1998 Senior Secured
Credit Facility and cash flow generated by operations will be sufficient to fund
the Company's normal working capital needs and capital expenditures for the
foreseeable future. In addition, to the extent that the Company were to borrow
all amounts then available to it under the 1998 Senior Secured Credit Facility
in connection with one or more acquisitions or in connection with significant
capital expenditures, either in the short-term or in the long-term, management
believes that cash generated from operating activities will be sufficient to
fund the Company's operating expenses and debt service needs for the foreseeable
future. Additional financing, under the 1998 Senior Secured Credit Facility or
otherwise, may, however, be required in connection with an acquisition or
acquisitions which the Company may consummate in the future. To the extent that
any such additional financing was needed, and could not be obtained on terms
favorable to the Company, if at all, the Company's ongoing capital improvement
efforts and acquisition activity would likely be reduced or delayed as cash
generated from operating activities is used for operating expenses and debt
service.
INFLATION
The Company does not believe that its financial performance has been materially
affected by inflation.
18
PART II - OTHER INFORMATION
Item 4. None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The following exhibits are being filed as part of this Form 10-Q:
EXHIBIT NO. DESCRIPTION
----------- -----------
27.1 Financial Data Schedule for nine months ended
September 30, 1998
27.2 Restated Financial Data Schedule for nine months ended
September 30, 1997
(b) Reports on Form 8-K
On July 7, 1998, the Company filed a Form 8-K/A to provide the
required historical financial statements related to the acquisition
of Amerivend Corporation on April 24, 1998.
On August 28, 1998, the Company filed a Form 8-K announcing the
resignation of the Company's Chief Financial Officer.
19
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunder duly authorized.
MAC-GRAY CORPORATION
November 16, 1998 /s/ Neil F. MacLellan
----------------------
Neil F. MacLellan
Chief Financial Officer
20